Although most currency traders use either fundamental or technical analysis approaches, the most successful traders do not limit themselves to just one Forex analysis technique. While the two approaches seem diametrically opposed, they can, in fact complement each other and make it easier for traders to identify positions they should take as well as when they should enter or exit them. How do you bring together the two approaches to make a single winning forex trading strategy?
Before we proceed, however, we should first consider the similarities and differences of these two distinct forex analysis approaches. Essentially, both seek to predict the movement the exchange rate of a particular currency pair will take. However, technical analysis does this by looking at past price movements in an attempt to predict future price trends. On the other hand, the fundamental approach uses upcoming and breaking economic and political news to determine price movements by considering how the news affects market sentiment. The main analysis tool of technical analysis is the chart; fundamental analysts, however, swear by the forex calendar that collates new and upcoming developments as well as their expected effects on market volatility.
To combine the two forex trading approaches, the currency trader first uses technical analysis to look at past price movements of the currency pair he is interested in trading. He does this by charting historical price data in order to determine a trend for the price movements as well as identifying support and resistance levels. Once we know where the price has been, however, the next step is to identify where it may be going. And this is where fundamental analysis comes in. Every piece of economic and political news that is reported generates a certain level of volatility in the markets, ranging from low impact for minor events such as the announcement of a national holiday to high impact for major announcements such as an interest rate hike.
There are now several trading strategies that the trader can use with this forex analysis in hand. Before he begins trading, however, the trader uses technical analysis to determine support and resistance levels as well as if prices are trading in a range. “Range” means that no matter which direction prices are moving, they will always return to the original price. He can then choose to ‘trade the news,’ by using the market sentiment resulting from the news to determine the trend the price will take, and open or close a position accordingly. Or he can choose to trade ‘breakouts’ or ‘ranges’.
When a trader trades breakout, he anticipates that a particular piece of news will cause prices to break out of their support or resistance levels. On the other hand, if they trade ranges, they will avoid trading around events that can cause high volatility, since they may cause prices to break out of the range they are moving within. No matter what approach they take, however, they still risk being wrong so they should always hedge their bets by trading with a stop loss order so they can limit their losses if the trade goes against them.