Fundamental vs Technical analysis
What’s the difference and why does it matter?
When it comes to Forex trading, there are two schools of thought used by investors to forecast the value and future movements of any given currency. That is fundamental analysis and technical analysis. The two methods are completely different but are intended to produce the same result; an increase in value. Some traders passionately believe one method is superior to the other, disagreeing on many trends and movements. However, it’s becoming more common among traders to use a combination of the two before investing.
Fundamental analysis uses an economic approach in determining currency movements. Financial, social and political forces also come into play. Central bank movements, interest rate cycles, inflation, manufacturing and services, employment figures and other various economic barometres are used in this analysis. Interest rates can significantly influence currency values. If one country’s interest rates are higher then another country, it holds a higher interest rate yield. Therefore, the currency could be more valuable due to a positive interest rate swap.
On the flip-side, quantitative easing programs used by central banks to stimulate growth can lower the value of the nation’s currency. A brief example is when the U.S. dollar tumbled after the Federal Reserve started printing money on the back of the global financial crisis.
Sensitive or tumultuous meetings between nation leaders can also influence foreign exchange values, if there are unresolved economic issues. Trade talks between the United States and China can be used as an example here. Sometimes, even passing comments by country leaders can result in a buy-up or sell-off.
Unlike fundamental analysis, technical analysis reviews past trends and patterns to identity future trading opportunities in the market. The discipline has a strong emphasis on the use of charts to highlight price points in the short-term and the long-term. Lines of resistance and support, price analysis, moving averages, “head and shoulder” patterns and a relative strength index are some of the tools used by technical traders. The method is a psychological technique, based on the belief historic market movements can predict future behaviour. Technical analysis is used as a tool to determine entry and exit points for a trade, although there’s no guarantee the point will be accurate. Neither technical nor fundamental analysis can guarantee an outcome in your favour.
The below chart of the ASX200 is an example of resistance and support lines, identified over a 3-week period.
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