Forex traders have different trading styles and strategies when approaching the market. But regardless of that, they use either technical or fundamental analysis. Or both – but never none.
Technical analysis deals with interpreting previous market data to forecast future price action. More precisely, it deals with interpreting charts.
Different types of charts, different patterns, and different trading theories exist. Candlestick charts are the most popular ones nowadays, but bar charts were used before.
Classic technical analysis patterns were spotted long ago, typically on the stock and commodity markets, but they still work today, even in the FX market. Such patterns are the head and shoulders, rising and falling wedges, double and triple tops and bottoms, bullish and bearish flags, or pennants.
In time, some other patterns emerged, complementing the classic ones. For instance, the Japanese candlestick patterns, such as the hammer, Doji, engulfing, morning and evening stars, dark-cloud cover, piercing, and so on. Their main advantage is that they are less time-consuming than the classic ones, and have now become an integral part of technical analysis.
Trading theories added more complexity to the field and, some argue, more accuracy in predicting future price levels. Examples are the Elliott Waves theory, Gartley, Gann, Drummond, Point and Figure, etc.
Above all, the main advantage of using technical analysis is that one can apply the same rules and principles everywhere. For instance, one can easily conduct online trading in South Africa using only technical analysis.
Fundamental analysis is different. It deals with interpreting and incorporating economic, political, and geopolitical data into an analysis and acting on it.
Thus, knowing the local economic data that might impact a currency pair is mandatory. After all, an exchange rate expresses the value of one currency in terms of another, so both currencies might move. Therefore, the economic data from both countries or regions plays a key role in the fundamental interpretation of a market.
Take the job market, for example. In the United States, the Non-Farm Payrolls report is released monthly, at the start of the month, together with the unemployment rate.
It is one of the most important pieces of economic data for traders watching the US dollar. And, it moves the entire market because of the dollar’s role as a world reserve currency.
But for one trading a currency pair, the job data from the other country or region also matters. In our example, South African economic data matters as well, albeit it will not move the exchange rate as much as the data out of the United States.
All in all, traders use technical and fundamental analysis to interpret financial markets and trade. But only technical analysis gives us the ability to distance ourselves from the local market and simply trade charts and levels. However, its main drawback is that the market typically moves on economic data releases.
Therefore, a trader should combine the two in such a way that a competitive edge results, which is much needed when trading financial markets.