Types of Analysis
The aim of fundamental analysis is to identify events external to the financial market itself which could impact price movement. These can be local to the country of a currency or significant global events. They can be economic news or events, political decisions or even natural disasters.
Significant Macroeconomic Indicators
The health of an economy is often reflected in one or more of a set of indicators known as economic or macroeconomic indicators.
These indicators are based on statistical data such as Gross National Product (GNP), Gross Domestic Product (GDP), Consumer Price Index (CPI), which measure the efficiency of an economy.
A government publishes this data in regular reports, which can immediately impact the value of the currency of that country. There are several other such significant macroeconomic indicators including:
- Inflation rate
- Retail sales index
- Employment indicators
- Consumer confidence levels
Major Geopolitical Events
Major events of this type, both domestic and international, can directly and indirectly, impact one or more nations.
They generate strong emotional and psychological sentiments in financial markets including the currency and equity markets.
Some example of significant geopolitical events could be:
- Economic disharmony between major countries, such as a trade war, imposing sanctions or import restrictions
- Oil production changes or any events that drive the price of oil
- Political events like Brexit that generate vast uncertainty and impact markets worldwide
Why GDP and Inflation Matter
GDP is a measure of a country’s production output in terms of goods and services over a defined time period, such as a quarter or a year.
GDP is probably the single most significant macroeconomic indicator because it reflects the overall health and efficiency of a country’s economy. Many factors such as capital inflow and investment, government spending, manufacturing output and significant other factors are taken into account.
Inflation measures sustained increases in the general cost of items over a fixed time period. It is significant because it indicates the decline in strength and purchasing power of the country’s currency. Central banks strive to control inflation and maintain a smooth economy while preventing deflation.
Technical analysis ignores events external to the financial market and focuses solely on historical price data and patterns of an instrument as a means of predicting future price movements.
It works especially well in Forex because the market does tend to repeat patterns and trends over time. Factors that lead to this include the large number of traders, many of them investing vast sums, which generates huge liquidity. Add to that the market’s sensitivity to significant trends within a country and the result is patterns of price movement that repeat in the market over long periods of time.
However, technical analysis is also used to detect and predict patterns in very short time frames too.
Benefits and Disadvantages of Technical Analysis
Benefits of Technical Analysis
Correctly identifying indications of price movement patterns and accurately predicting what will happen next is at the core of a successful trading strategy. That involves determining the best entry and exit points for trades to maximize profits while minimizing risk. Technical analysis is the choice of many for achieving this.
There is a certain logic to why technical analysis may be so popular. Because the majority of traders use it, they all depend on the same indicators and may take similar actions at pre-determined price points, which makes forecasting more accurate than might be expected from a purely statistical perspective. It may have become something of a self-fulfilling prophecy.
Disadvantages of Technical Analysis
No market is totally predictable all of the time. That uncertainty is part of the rationale that drives market trading. Historical price patterns may not always repeat in exactly the same manner or over the same timeframe, useful though they undoubtedly are as a predictive tool.
Traders are strongly advised not to depend totally on a single analysis technique or indicator but to take input from as many reliable sources as possible. Allied to a robust risk management strategy to limit potential losses, the result is a far more dependable trading strategy.