The difference between Fundamental and Technical analysis
Have you ever wondered which type of analysis is better for a trader? Is it better to be a fundamental trader or a technical trader? Here we will give a short overview of the differences between these two types of analysis and which pieces of information traders tend to look at.
Technical and Fundamental analysis comparison
Defined by forecasting price movements using chart patterns and technical tools
Data considered for trade setup: Price action (trading from charts)
Suits best for short, medium and long term trades
Skillset suggested: Chart analysis
Defined by use of various economic data to establish value and target price
Data considered for trade setup: NFP, CPI, GDP, Interest rates, etc
Suits best for medium and long term trades
Skillset suggested: Economics and data analysis
Fundamental analysis involves learning the economic well-being of a country and the currency by reading relevant data. It does not take into account currency price movements. Rather, fundamental traders use data points to determine the strength of a currency.
A fundamental trader analyses economic data, such as the country’s inflation, gross domestic product (GDP), non-farm payrolls (NFP), and even speeches delivered from central banks and other institutions with a tendency of affecting the strength of any selected currency.
Below is an example of an economic calendar used by fundamental traders to keep up to date with the latest data releases. Here you can read how to use an economic calendar as a trading tool.
As you study the relative trend of data points, a trader is analyzing the relative health of the country’s economy and whether to trade the future movement of that country’s currency.
Below is a summary of the general effects that economic data tends to have on the strength of a currency. However, this is not guaranteed as there are many factors that influence currency movements.
Learn how economic data affects currencies
Economic event – Expectation and effect on currency
NFP Non-Farm Payment Report – ‘Actual’ greater than ‘Forecast’ is good for currency
Central Bank increases Interest Rate – ‘Actual’ greater than ‘Forecast’ is good for currency
Trade Balance in deficit (imports > exports) – A low reading is seen as negative for the currency
ECB`s President speech – More hawkish than expected is good for currency and dovish is considered negative for the currency
Technical analysis involves pattern recognition on a price chart. Technical traders look for price patterns such as triangles, flags, and double bottoms. Technical traders also use trading tools like Bollinger Bands, Relative Strength Index, Moving Averages, etc to determine the trend of the traded instrument and oversold/overbought areas with a simple glance over price charts. Based on the pattern, a trader will determine the entry and exit points. Unlike fundamental traders, a technical trader is not as concerned about why something is moving because the trends and patterns on the charts are their signals.
Below is an example of a chart pattern – the double bottom pattern. The market makes the first low, rebounds slightly before creating a new low, and subsequently gains upward momentum as the trend reverses. Technical traders will look to set a stop loss at the recent (lowest) low and wait for the market to produce higher highs and higher lows before placing the long trade.
In practice, technical traders will need to identify the pattern as shown above on the GBPUSD m15 chart where the “W” shape can be seen.
A technical trader will learn the price action, trend, support, and resistance levels observed on a chart. Most of the patterns used in technical analysis can be applied to any markets as well with different timeframes.
Additionally, traders make use of technical indicators and oscillators which are added to a price chart when analyzing the markets. Moving averages (MA), Bollinger Bands (BB), Relative Strength Index (RSI), and stochastic (STOCH) tend to be some of the more common tools in a technical trader toolbox. Indicators are preferred by technical traders because they are easy to use and provide clear signals.
As most technical tools are considered lagging indicators, it is suggested to use custom technical tools over default ones found on any trading platform, to remove the noise and minimize false signals on your real-time trading experience. Please find custom developed trading tools from our marketplace.
Benefits of technical analysis
Mastering the technical analysis does not require special skills that many fundamentalists claim. Getting started in technical analysis can be done quickly by learning how to recognize the direction and strength of trends. This will show you, how to use the trend analysis and help you determine which pair to trade and the direction to trade it.
Below, is an example of how a technical trader would notice this 1200 pip (point) trend where the USD is very strong relative to a very weak AUD (which is why the currency pair is moving down). Furthermore, it is clear to see that the currency pair is trading in a strong downward direction. This is referred to as a tend and traders make use of key levels, levels of support and resistance (SR Levels), and technical indicators to identify trends as soon as possible and with accuracy.
Learning how to identify strong and weak currencies will provide traders with an indication of which currency pairs are most likely to trend and lead to higher probability trades. A trader would trade in the direction of this particular trend by selling the AUDUSD pair.
Conclusion for Technical and Fundamental Analysis
Fundamental and technical analysis involves very different strategies and approaches to trading; providing different ways to support trading decisions, and when to enter or exit a trade. While some traders prefer to use these types of analysis separately based on their preferred trading style and goals, many use a combination of the two. The benefits of combining fundamental and technical analysis are wide-ranging and might lead you to more profitable trades overall.
Fundamental traders monitor economic data releases, and many do so with the intention of trading the news (economic events). It is essential that traders apply firm risk management when doing so as volatility can spike immediately after important releases.
Technical traders have different styles and strategies that rely on technical tools and price action. Technical trading is also suitable for automation, where your strategy can work for you 24/7.