Forex Trading: Let There Be a Method to the Madness

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The $5 trillion-a-day, round-the-clock forex market no doubt attracts greenhorns and keeps professional traders busy. There’s no dearth of advice for newcomers as experts analyse various strategies threadbare, leaving a new trader even more nervous and confused. One of the most heated arguments that fuels debates among traders is whether technical analysis or a fundamental approach is better as a forex trading strategy. The debate is not restricted to the equity markets alone. In the forex markets, too, proponents of each of these strategies from either side of the fence talk about how their strategy is superior.

What do fundamental and technical analysis mean and what implications do they have in forex trading? Fundamental analysis involves assessing the economic factors that are likely to influence an asset class, in this case, currency. Based on the currency be ingtraded, a fundamental forex trader will look at a country’s inflation, trade balance, gross domestic product, employment data, non-farm payroll (NFP) data, the Central Bank’s benchmark interest rates, and other data points that could have an impact on the economy. An analysis of these data points gives the trader an indication of the relative health of the economy. Companies, banks, investment management firms, hedge funds, and institutional and retail forex brokerage firms use fundamental analysis as a tool to assess how each of these factors could influence the value of a country’s currency. In technical analysis, traders examine the historical prices of the specified currencies to recognise trends and patterns and based on this they predict the price movement of a currency. Traders use automated tools such as moving averages, Bollingerbands, Relative Strength Index, and stochastics to examine fluctuations in the value of the currency and discern patterns that help them establish support and resistance levels and determine pricing actions. A typical day trader close sall positions before the end of the day, eliminating the possibility of being adversely affected by events or large moves overnight.

Conservative forex traders prefer to square off their positions during major events. However, there’s a breed of traders that thrive on the dramatic volatility that surround the news releases. News-pegged strategies, often called  currency news trading, involves watching the market closely to react quickly and open and close positions optimally during such periods of high volatility.Notably, these events do not include negative surprises, but are anticipated market events such as monetary policy. The strategy is similar to equity traders tracking quarterly earnings or other anticipated events relating to companies. Buy-the-rumour-and-sell-the-news is the trading maxim of this class of forex traders who take positions based on the information they have. Once the data is out, the traders will compare it with market consensus and revalue the exchange rate based on whether the outcome of the data was negative or positive.

News-driven trades or Bollinger bands? The choice is not easy

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However, the advocates of technical analysis argue that retail investors trading from a home computer should not take the risk of basing their trades on news because, by the time they even have a whiff of the news, the markets have already priced in the event. They believe news-trading is impractical for retail traders because this strategy calls for execution of the trades at lightning speed. They state that such a strategy is suitable for big institutional investors who have the best fibre optic connections and access to Bloomberg terminals and priority data feeds. Thus, by the time an average retail trader wants to make a move, the event has already happened.

However, the fundamentalists argue that such events are a part of the events calendar, and it would be foolish to ignore the opportunities presented by these events altogether and proceed with technical analysis like a blinkered horse. Thus, a better approach would be to digest, understand, and incorporate all the news into the trading strategy rather than shutting off your computers and waiting on the sidelines.

Having the best of both the worlds

The argument rages on, and there seems to be no definitive answer to whether technical analysis can be a substitute for fundamental analysis. However, most technical traders seem to incorporate a little bit of fundamental analysis into their strategy, and fundamental analysts seem to incorporate technical tools such as volume trends to gauge market sentiment. Charting tools are gaining immense popularity because they enable traders to look out for spikes in volumes. So, the answer to this poser is a blended strategy that allows traders to incorporate the positive components of both the technical and fundamental strategy. Jamie Saettele, a senior currency strategist, advises that traders should “react to the reaction” of news releases. Thus, they can buy cheaply on an uptrend or sell expensive on downtrends when the price is close to resistance.Technical tools will help in identifying the support or resistance points. You are integrating fundamentals into your strategy and making sure amidst the frenzy that there’s a method to the madness.

Tags: currency trading

Category: Finance