Lot of Forex Traders ask me should they be using technical analysis for trading forex or is Fundamental analysis is more reliable. I know this confusion comes since both forms of forex trading are different schools of thought but both are highly effective.

Just to set the pitch straight, let me mention two lines about forex technical analysis and what is forex fundamental analysis.

You see, forex currency pair behavious is goverened by the financial enviornment. For e.g. if  US government is promoting import, that would mean that importers will have to pay less for getting foreign goods. This essentially would mean that the other countries will face scarcity of US dollar and this would make the Dollar stronger as compared to other currencies.

Forex Analysis using these fundamental financial news is called Fundamental Analysis.

 

The other school of thought goes with the assumption that the past behaviour of any any currency pair can be used to predict its behaviour in future. Thats what Technical analysis is. Its about reading the previous behaviour of a given currency pair on the forex chart using a variety of technical indicators.

 

But choosing one over the other needs some form of understanding about what kind of trader are you. Lets look at some pros and cons of both the methods -

Forex Fundamental Analysis -

- It is most of the times very reliable method. It works very well on all the currency pairs.

- Typically it works on the larger time frame charts such daily charts, weekly charts monthly charts. So the trader doesn't has to trade too often as the trades last for days to weeks to infact sometimes months.

- The profit potential is very high. They range from 300 pips to sometimes 1000s of pips on a single trade.

- No wonder, since the profit is high, if the trade goes negative, the loss can also be high. A typical stop loss can be for 100s of pips which is far outside the budget of a trader with  limited capital to invest.

- Requires a lot of careful study of the financial news and other fundamental announcements such as Non Farm Payroll (NFP), FOMC etc.

 

Now lets look at Forex Technical analysis -

- It is also is a very reliable method and is very widely used in the market.

- One of the biggest advantage is that it can be used in any timeframe such as 5 min chart, 15 min, 30 min, 1 hr, daily etc. Though the smaller the timeframe, the less reliable the analysis will be . Still they work very well for day trading.

- They are not complex to understand and use. Though one needs a good strategy that works very well to trade forex.

- The only and biggest technical analysis has is that the fundamental annoucements can override the technical analysis. For e.g., if the technical indicators are indicating that Dollar will go bullish and immediately a news come out from federal bank that they us housing market is going ina loss. Guess what will happen. It will plunge the dollar significantly across all the other currencies.

 

You must have noticed from above points that both the methods are applicable for different kind of traders. While the bigshots like financial institutions that have big capital to trade would like to use fundamental announcements as the primary way to trade.

For the other traders like you and me, technical analysis works the great. Like I mention it works on all the time frames. But the larger the timeframe, the more reliable the ondicators become. The indicators will work better on 1 hr chart  thank on 15 min chart.

 

HOWEVER, the best way to trade forex is by combining both the methods. By this what I mean is that if I am using technical analysis I'll also keep myself aware of what is happening in the fundamental market such as what is the outlook of the currencies on which I am thinking of trading or if there is any fundamental announcement that is about to come.

So, definitely technical analysis work the best. But being aware of the fundamental happenings will definitly increase the pips profit.

For that to happen you need a good forex trading strategy that has good foundation. Which is easy to understand and use.

I'll tell you about how to evaluate a good forex trading strategy in next post.