The age-old debate among traders about which is the better way to make decisions—technicals or fundamentals—misses the point. The two are not mutually exclusive; they are complementary. Activity in the interbank FOREX market is far larger than the retail trading platforms and commodity markets. The relative volume of retail trade is insignificant compared to institutional activity. Many institutional dealers rely heavily on the fundamentals, so it behooves the retail trader to have a passing knowledge of the fundamentals, if for no other reason than to understand what the big players are up to. This chapter aims to provide an insight into what factors fundamental traders consider when they make their trading decisions.
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What is Fundamental Analysis?
The fundamental trader seeks to figure out the reasons behind buying or selling currencies in the FOREX markets in order to predict how those making such transactions will behave in the future. The technical trader simply accepts the fact that these transactions are taking place and looks for familiar price patterns to repeat. This chapter takes a quick look at some of the principal fundamental influences on the markets. Because knowledge of the fundamentals usually requires both academic preparation and considerable market experience, they are often used more frequently by traders who have a professional background. If you approach both analysis tools with an open mind, you might find that some of the elements of a fundamental approach might prove to be useful along with technicals. Figure out what works for you.
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All Price Moves are Not Created Equal
Many assert that the fundamentals are already priced in the markets. Decades of trading experience suggest that this theory is utter nonsense. Take a look at how the direction of the markets can be abruptly reversed by a central bank decision or an economic release.
As for the difference between fundamental and technical analysis, the two methods approach the markets from different directions. Technical traders look for future guidance from past and present price patterns, while fundamental analysts like to dig in and try to figure out what is behind the price patterns that the technical traders are readily accepting.
A basic flaw with pure fundamental trading is that it is often impossible before the fact to identify which fundamental factors will be dominating trade, because those factors tend to change quickly. A key flaw in pure technical trading is that it can lack the depth that comes from fundamental analysis. In other words, not all price moves are created equal. Here is how a bank dealer from the southern tier of Europe approaches the FOREX markets:
Today’s data really puts into context those three basics that move fx rates: relative growth differentials, yield differentials, and other stuff. In a rising growth/low volatility environment, yield differentials matter more. In the current falling growth and risk aversion environment, yield differentials matter little. It’s primarily about future relative growth expectations, and how some economies are soon to be perceived as falling more behind the curve than others.
An approach that might be considered is to use whatever technical approach works for you and supplement that strategy with an awareness of what is happening fundamentally.