In a market that, at the last count, boasted daily volumes of around $4 trillion, not to mention a bewildering myriad of permutations in terms of currency pairs, a foreign exchange trader without a system would appear to be about as much use as a beaten docket.
It is perhaps something of an axiom to posit that any given currency is likely to move on the back of news about that country’s economic well-being. An interest rate differential here, a drop in GDP there; they all create money-making opportunities for the canny trader.
So while price action can certainly be affected by economic and geopolitical newsfeed, the tendency of currency markets to trend and react to established key levels means many foreign exchange (forex) players employ technical analysis as a key plank of their strategy.
Therein lies the difference between fundamental and technical tactics. Currency punters therefore face something of a double-edged sword when it comes to which style of analysis they choose.
Ostensibly at least, while there are clear definitions separating these two schools of thought, there is one common factor that does remain constant and that is dealing with market noise.
Whichever style of analysis is favoured, an ill-disciplined trader is likely to quickly find themselves overwhelmed, either with the amount of news, views and macroeconomic updates in the 24-hour-a-day currency market from a fundamental point of view or - on the technical side - the sheer breadth of the world of technical ‘indicators’, commonly referred to as ‘expert advisors’ (EA).
Many companies offer forex trading services, among them CMC Markets, FxPro, IG Index, Alpari, Capspreads, City Index, easy-forex, and FOREX.com. But before one even contemplates choosing one or adopting either a fundamental or a technical strategy, Zoe Fiddes, head of UK business at easy-forex counsels that ‘every trader must have a plan which contains a checklist of triggers before you execute in the market.’
Anatomy of a technical trader
The forex market never sleeps and its liquidity and leverage mean it attracts very active traders. The profile of this type of market participant means they tend to use short-term strategies which would be difficult to trade when using fundamentals, so a large number of them rely on technical analysis.
‘Many traders prefer to follow a technical strategy as they believe there is less ambiguity in following rules based on charting signals,’ says Fiddes. The idea is that by adopting a technical-based strategy, a trader can carefully plot both entry and exit points with as much precision as they see fit based on a their particular
risk appetite.
The watchword even in this complex field has to be simplicity. Do not overthink and do not over-analyse. ‘If you choose to go down the technical route you will soon realise there are hundreds of indicators available and your mission will be to find what works for you,’ Fiddes counsels. ‘You do not want to be using multiple indicators at one time, keep it simple. Understand price patterns and the indicator and test it on various currency pairs and time frames. Write down your plan on how you will use this indicator to enter and exit the market.’
Many experts believe the currency markets are the most prone to trend and chart-based strategies can perform very well in this arena as a result. Alejandro Zambrano, a market strategist at FXCM, uses the example of the dollar/yen (USD/JPY) cross as he points out ‘[The pair has] been trading lower since 1973.’ A 40-year pattern is a trend to note in anyone’s book but it is always best to keep testing and probing. As a technical analyst ‘a good idea [is] to apply a simple 20 period moving average and see if it has a clear bias,’ Zambrano adds.
The FXCM man suggests technical tools such as Fibonacci retracements/projections, moving averages and oscillators should be used in order to highlight trends, thus confirming a bias. ‘When a clear bias has been established the trader wants to buy or sell when the daily and weekly time frames agree,’ he says.
Despite the common assumption of a currency pair’s ability to trend, Zambrano does warn: ‘It’s important to remember that markets don’t always trend and its therefore important to stick to only one market - rather than skim trough the various currency pairs available until a decent trend can be found. If no strong trend can be found then it’s better to wait before employing trend following techniques.’
Forex fundamentalists
On the flip side of this is the case for the fundamental approach. After all, it is the macroeconomic data that drive the larger trend of a particular market. ‘Traders should be aware of the major data announcements that steer market sentiment,’ says easy-forex’ Fiddes. Those data points, specific to each country, include; gross domestic product (GDP), retail sales, consumer confidence and purchasing managers indices (PMI) to name but a few. These are all data points that, if an unexpected level is announced, can cause volatility, and thus large price swings that no technical-based strategy could foresee.
Brenda Kelly, technical analyst at IG markets states, ‘Being blind to the fundamental news flow would be a mistake, for instance it might not be the best time to place a long trade on euro/dollar when the Federal Reserve chairman, Ben Bernanke is due to give a testimony.’
There is plenty of scope to argue that the face-off between fundamental and technical trading strategies is something of a false dichotomy.
Certainly there are market gurus out there evangelising the social trading gospel who would question whether or not the difference between the various market analysis techniques is even relevant in their medium. Alon Levitan, marketing operations manager at eToro is one such iconoclast.
‘As a social investment network numbering almost three million traders, at eToro we see traders use every kind of market analysis technique under the sun,’ Levitan tells Shares.
He explains the eToro approach: ‘In social trading, market parameters are superceded by trader parameters which we can define as performance and sentiment, because instead of accessing the markets directly, I now access the market through the filter of the traders I am copying. If a trader performs well, does it matter whether he/she uses technical or fundamental analysis? The answer is a resounding no. What matters is whether I can make a gain by copying this trader. To determine that I don’t need to know if the trader follows the news or watches technical charts, I don’t need to know what indicators he/she is using and I don’t need to know what news service they subscribe to. I can find all I need to know in the trader’s statistics.’
Best of both worlds
Many forex traders are now opting to take aim at the markets armed with a
new style of analysis called ‘inter-market analyses’. While this multi-asset class approach is far from new, the novelty lies in its implementation in the forex market at retail trader level. Today’s traders must harness a ‘best of both’, which combines elements of fundamental and technical analysis.
Inter market analysis takes into account multiple view points across all four asset classes. In doing so, it paints a clearer macroeconomic picture of the sentiment driving markets from both a fundamental and technical perspective thereby adding weight to a trader’s conviction.
‘Analysing correlations between certain markets can greatly improve a trader’s edge in the markets,’ says Todd Gordon, founder of TradingAnalysis.com.
‘By analysing correlations across different markets, we [traders] are able to correctly identify such things as leaders and laggards in trend bias,’ Gordon adds.
An example of this would be charting the S&P 500 with multiple currency pairs on a percentage change basis. In doing this, a trader can clearly flag up both correlations and inverse correlations.
Finally, before even assessing what style of trader you are going to be, you simply must tailor your style according to your individual risk-and-reward tolerance. Some technical traders may utilise a system on a five-to-ten or 15-minute chart that requires a high-frequency trading approach. These sorts of systems can have a high success rate, but the risk/reward ratio is also reduced, so you need to achieve a higher success rate to break even.
On the other hand, a fundamental trader may opt for fewer trades, choosing to only get involved around certain announcements looking to target large price swings over an extended period. This style is normally utilised by a ‘swing trader’, willing to hold positions over a longer time frame. A strong stomach is needed for this style as traders are likely to have more losing positions than winners, but owing to a higher risk/reward ratio, traders can afford themselves a lesser win percentage.
In the final analysis, whether you have a technical bias or not, the importance of macroeconomic knowledge cannot be underestimated. Being aware of how data and events drive market sentiment is a huge plus even if your strategy is more chartist that editorial. Being aware of the data and understanding its ramifications both complement and elucidate technical analysis.
Levitan of eToro sums it up: ‘Some of our traders are fundamental fanatics, posting news updates on their feeds every couple of hours, whereas other traders bypass the news all together and hang on to their support and resistance lines for dear life. To be fair, most traders utilise a combination of both, which makes sense because both are valid analysis techniques, and why wouldn’t you use all the tools at your disposal?’.
