By Charis Mountis, Head of Dealing, ForexTime Ltd
Every morning, John opens his Internet browser and goes to his favourite financial and business news site to check the latest big stories, economic calendar and market events. He soon spots an interesting piece about the Russian economy; in the aftermath of the Ruble’s losses on the back of the drop in oil prices, Prime Minister Dmitry Medvedev thinks a recession could hit his country. John finishes reading the piece, and then opens up his trading account and places a trade for the Ruble to fall against the US Dollar. When political leaders make pessimistic economic statements, the impact on the country’s currency is often negative as the market reacts in fear or speculation.
This kind of currency trading is based on economic fundamentals and investor sentiment. It’s fascinating to watch the speed at which traders react to news events like this, particularly in the online trading environment. Another aspect of fundamental trading is economic releases from governments, which use statistical data to track the performance in different sectors of their economy. A significant economic indicator is a country’s overall performance, which can be seen in the benchmark called Gross Domestic Product, or GDP. When large, developed economies like the Eurozone or United States release their GDP data, traders watch the numbers for signs that these influential economies are doing well or…not so well.
Let’s take our fictional trader John’s perspective for a moment. He knows that the Eurozone’s GDP figures are due out at 10am on the 17th of January. He does his research, reading about what the analysts are saying about Eurozone GDP, and figuring out what to expect on the day. Before, during and after the Eurozone’s GDP figures are announced, he places trades on the Euro versus its currency rivals, like the USD or GBP. The trades he places depend largely on whether the figures have come in as expected, below-expected, or above-expected.
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In contrast to this type of trading, let’s look at the fictional example of Jeff, who only places trades based on technical analysis tools. In the mornings, Jeff goes directly to his trading account and opens up various charts that give information about price direction on the currencies he wants to trade. He believes that it’s largely a waste of time to read the news, because all the information he needs is already included in the current price of the currency – it’s just a matter of forecasting which direction it will take next before placing a trade. Jeff trusts his Relative Strength Index (RSI) to show when a currency is overbought or oversold, for example. He relies on the Ichimoku Cloud tool to give him a big-picture view of price directions, because it is a charting tool that combines more indicators than any other. In short, technical analysis is all about the numbers, charts and patterns; instinct or sentiment plays little part in this style of trading.
That’s not to say that technical analysts completely ignore the news or economic data; instead, they assume it’s already priced into the analysis tools. What’s the difference? Let’s take the same situation as perceived by fundamental and technical traders. The Eurozone releases GDP; the fundamental trader sees it is lower-than-expected and places a trade for the Euro to drop short-term against the USD. The technical trader watches his charts for a clear direction, and decides his trades based on the technical indicators. If the technical indicators he uses signal a rise in the Euro, he will place a trade for the Euro to rise against the USD, which – counterintuitive as it may be compared to our fundamental trader’s view – could very well be the case in today’s complicated trading environment.
Both trading styles have their advantages and disadvantages, the question is, which type are you? It’s not so easy to predict. For example, if your background is in economics and business, you may be inclined towards fundamental trading, because you understand the connections between market events and currency movements. If, on the other hand, you studied statistics or mathematics, and have a very strong grasp of how currency prices work within repeated market patterns, then you may be inclined towards technical trading.
Whichever style you decide to try, if you’re new to currency trading, before placing trades, it’s best to research thoroughly and use the educational tools available to you. Both types of trading need to take into account the market risk factor; such as surprise market reactions, sensational breaking news that distort normal trends, even strange things like government shutdowns, as happened in the US in 2013. This had the effect of slowing down investments on an international basis, because so many market-moving events come out of the world’s largest economy.
There’s even a third possibility; that you’re the kind of trader who can comfortably combine both fundamental and technical analysis to inform your trading decisions. Advanced and experienced traders can pick and choose their method depending on the event or asset they are trading, and it’s said that they can often be very successful by combining different types of know-how.
In conclusion, currency trading decisions are almost always based on some form of data, not just on instinct or a feeling, and it’s a wise investor who can tell the difference.
Disclaimer:The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. ForexTime Ltd, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.