Fundamental Forex Analysis

Technical analysis is not 100% effective.  The future, unfortunately, cannot be predicted based upon trends of the past.  The market is far too volatile to simply fall into these patterns.  More often than not, technical analysis is right: this is why it is so widely used.  But it is not a guarantee.  This does not mean that the alternative is always right either.  Fundamental analysis, the bane of pure technicians, relies upon internal data from a specific market to try and gather the direction that the market is headed in. In the realm of trading currency, this means looking at data such as Gross Domestic Product, trade deficit data, and of course, the competition (other currencies).  The ideal is to know a specific nation’s currency so well that you can ascertain when it is undervalued, thus triggering a buy signal.  The main weakness of fundamental analysis shines through in this respect.  Unlike with technical analysis, no exact numbers are generated for market entry and exit points.

Fundamental analysis shares a big factor in common with technical analysis: it too isn’t 100% effective.  But it does provide a direction that technical analysis doesn’t.  Rather than basing a decision solely on past actions, it extrapolates the future based on the current state of affairs.  A sense of scientific reason is provided for it’s predictions rather than a simple graph or number.  The internal policy of a market is turned inside out trying to determine what the next logical step is.  Fundamental analysis falls short though, because it is often a matter of opinion.  What the studious trader sitting at home thinks is the best course of action for the Yen or Euro is not always what others think.  For those of you that want a little more “hard” data to base a decision on though, this is more your style.

So what do I recommend?  It should be obvious by my tone that I am not a fan of either technical or fundamental analysis alone.  But I do believe that together, they provide enough data to be effective.  Still, it must be noted that combined, the two types of analysis do not constitute an oracle.  It is still speculation to a degree.  At the very least, it is educated speculation.

Let me provide a few examples.  Through fundamental analysis of a market, you could discover that the Yen is undervalued, but based on the technical charts, it is still trading near an all-time high.  While hindsight may prove that the Yen was a profitable buy, the charts may dissuade a buyer.  The Yen could very well keep going up past it’s previous high and you would have missed out on a very profitable opportunity.

Or the exact opposite could happen.  The fundamentals of the Yen say that it is undervalued and the charts say it is time to buy.  So you buy 100,000 Yen.  But you end up being the only person to go this route, everyone else thinks that the market is at a top and sells.  Demand for the Yen drops, thus causing prices to drop respectively.  You’ve just made a losing trade.

Both of the above examples are very realistic possibilities.  Fundamental and technical analyses, alone or together, are not surefire way to make money.  There is another factor which must taken into account: trading psychology.