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Technical Analysis Versus Fundamental Analysis

Jun 20, 2008
Those who participate in the Forex market have two basic schools of thought in regard to analysis. One is technical analysis and the other is fundamental analysis.

Technical analysis believes that prices tend to follow patterns. Therefore, if one analyzes past price patterns, one can more easily predict what prices will be in the future.

Fundamental analysis, on the other hand, studies a nation's overall economy. Proponents of fundamental analysis focus on the "big picture," and believe that price trends are best predicted to analysis of the various economic indicators; this, in turn, gives a picture of the overall economic health, which in turn helps one predict what the market is going to do.

Of the two, which is better?

Well, neither is, really. In fact, each has its strengths and weaknesses, and when you use both types of analysis and work in tandem with them, you're going to get your most accurate picture. This in turn is going to make you a more successful trader. If you limit yourself to just one or the other, this can give you inaccurate results, which will lead to improper analysis; this, in turn, can cause you great disaster as a trader.

Why is this true?

If you utilize just fundamental analysis or technical analysis, you're only getting half of the picture. Let's take an example to illustrate this point.

If you are focusing strictly on technical analysis, for example, you might not put much stock in fundamental analysis, if at all. Your belief is that your price charts are your saviors, so that you have no need for economic indicators.

In studying your charts, let's say that you see an opportunity coming up. Three or four indicators are telling you that there's going to be a huge breakout. In fact, the United States dollar is looking as though it's going to go on a rampage, and you want to get in on it early. So you make the trade, sit back, and wait to see what happens. Of course, prices will soar, right?

But instead of rising, the price drops 50 pips. What happened?

To provide yourself some distraction, you flip on the television, and there, lo and behold, is the US financial report. In fact, the latest unemployment numbers have just been released and the number is much higher than was expected. Simultaneously, one of the world's largest companies has announced that its earnings were well under what it had forecasted, and sales are also expected to be sluggish for at least the next quarter.

These two elements have caused the price to drop instead of rise as you had expected. You would not have been caught out like this if you had utilized a little fundamental analysis along with all of your technical analysis and price charts.

However, you can't use fundamental analysis alone, either. Fundamental analysis is great at giving a "big picture" view, which gives you general trends in price movement. However, you can't get close enough in detail with this type of analysis to provide exit and entry points. For example, you may know that the Swiss franc will soon have a price increase, but you won't know how much. You also won't know when you should buy and sell.

Therefore, only by utilizing both technical and fundamental analysis in your trading system can you become a successful trader.
About the Author
Ian Armstrong is an avid Forex enthusiast.

Ian recommends downloading the free beginner's guide to Forex trading at Forex For Beginners
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