The eternal debate that most budding forex or CFD traders have centres around which form of analysis fosters more success. Is it better to be a fundamental trader or a technical trader? There is no data that suggests one form of analysis is better than the other. In most instances, it is rather the traders’ personality trait and attitude that will dictate which analysis is more beneficial.
Some FX traders will spend more time concentrating on price action and ignore almost everything else in their quest to perfect the art of technical analysis. Others will find it more comforting to study the economic data that cause market fluctuations. They prefer to put words to the picture, and so will concentrate solely on fundamental analysis. In truth, you will find that most traders combine the two different type of analysis and feel that this more rounded approach allows for the most success. We will explore the different methods of analysis in a little more detail below.
Much like sifting through balance sheets and PE ratios to determine the best share to buy, fundamental analysis tries to make sense of financial markets through the study of economic data and news flow. It also takes into consideration more than just economics, though, it factors in things like politics, society, and shifting social norms – some economists refer to fundamental analysis as the study of global psychology and human behavior.
By trying to establish “cause and effect” between price action and economic development, the fundamental analyst is searching for subtle “errors” in the market to take advantage of. The fundamental trader will have a suspicious nature and always be sceptical of price action, whilst this form of analysis does warn us on possible reactions in market attitude, it doesn’t give any indication of timing of a correction.
Advantages and Disadvantages of Fundamental Analysis
By understanding market dynamics and the drivers of an economy, the fundamental analyst possesses the confidence and composure to withstand market volatility and generally stay in positions longer. The longer the timeframe of trading the more accurate fundamental analysis generally becomes. The biggest drawback is that fundamental analysis can be subjective as opposed to objective. It doesn’t eliminate all the emotion from a decision. It can also be both time consuming and difficult to understand.
As online trading on financial markets become more prevalent, so did technical analysis. So technical analysts have not been around for as long as their fundamental counterparts. Most would agree that it is fast becoming a valuable form of analysis for traders and in the short term probably holds more predictive value than fundamental analysis. Technical analysts believe that the price action absorbs all information available and so there will never be an “error” in market price. There is a belief that price movements are not random. They also hold the opinion that price forms trends that repeat itself.
If you hold these values in your analysis, you will believe that by understanding human behaviour, the average person (and trader) are predictable. Therefore, it is possible to use an array of technical indicators to predict how price action will trade.
Advantages and Disadvantages of Technical Analysis
Technical analysis is simple to understand. It is thought that the technical tools at a traders’ disposal level the playing field. Retail traders and fund managers all have the same tools. By following a set of technical indicators, it easy to eliminate the emotion from trading. By focusing only on the price it minimizes the role of guesswork. By understanding the technical indicators, it allows for a quicker and more accurate assessment of the market. The disadvantage of this form of analysis is that because millions of traders are watching the same chart, we get a herd mentality. This allows for the bigger players to anticipate stop levels and intentionally trigger those stops.
It is interesting to note that the debate between fundamental and technical analysis bears a correlation to the age of the trader. Those that have been in the market for a longer time generally prefer fundamental analysis. Technical analysis only become popular as trading left the floor, this makes sense. Despite the ongoing debate it also important to point out that more often than not both forms of analysis come to the same end result. Fundamental and technical analysis both have their own unique subtleties.
There is not enough evidence to suggest one is better than the other, early indications are that fundamental analysis may have stronger predicative power over the long term. While technical analysis may be more accurate in the shorter term. This debate seems destined to rage on for some time. In the interim, I am sure everyone can agree that discipline is the still the most important trait of the successful forex trader.