The difference between technical and fundamental analysis is very wide. Fundamental analysis is the study of the economic conditions underlying a particular currency. Although it is not recommended that you trade only on fundamentals, it can be done. Position traders and serious investors trade only on fundamentals simply because they are trading for the long term and not the short term. There is no clear cut exit point based on price for the fundamental analyst as there is for the technical analyst, therefore short term traders should not study only fundamentals.
Essentially, fundamental analysis concentrates on the daily economic calendar and announcements made by senior bankers and central bank spokespersons. The fundamental analyst studies various economic indicators which are important to the economic health of a country and the subsequent effect on its currency. In studying trends and patterns on various economic indicators such as interest rates and unemployment rates, the analyst works out in which direction the currency of the economy is heading next.
Below is a copy of the economic calendar for Friday the 3rd May 2013, showing all the major economic announcements which are scheduled to be made. The announcements which will affect currency movements in a major way are highlighted by three red bars.
The key economic events were the Producer Price Index at 09:00am for the Eurozone and the Non-Farm Payrolls at 12:30pm in the USA. As you can see from the EUR/USD price chart snapshot below, there was little reaction to the currency pair on the PMI news (Blue arrow) but there was extreme reaction after the results of the Non-Farm Payrolls (Red arrow) were announced.
Traders who solely traded on fundamentals would have been seriously out of pocket if they had bought the Euro in anticipation of the Non-Farm Payroll news.
Technical analysis is the study of price movement and not economic fundamentals. The advancement in computer technology and the internet in the last 10 years have enabled non-professional traders to have real time prices on price charts just as the professional traders and institutional investors have in the past.
Technical analysts believe that the price of a currency has all fundamentals priced on the chart and that what you see is the collective behavior and emotions which cause price action. In essence, it’s the study of past price behavior patterns to determine where the price is going in the future. Because price charts can be viewed in historical time frame patterns ranging from 1 minute to 1 month, a trader has numerous trading opportunities. In addition, it is a lot easier to make decisions and pinpoint entry and exit signals based on the past behavior patterns of traders.
You don’t have to worry which CFD analysis is better, just combine the two and trade when both exhibit the same signals.
To determine which trading style suits you best, you need to fully understand your strengths and weaknesses. There is no ‘right’ way to trade, the right way for you might not be the right way for someone else. To have a chance of being successful you should find a trading style that suits your personality. A good indicator of what CFD trading style you are suited for might be in the sports you play or like to watch.
There are only really two types of traders; those who are trend traders and those who are counter-trend traders. The difference between the two kinds is that a trend trader is patient, invests time into trading and follows a definite CFD strategy methodology. A counter-trend trader looks for the quick kill and is looking to close the trade very quickly. Counter-traders tend to trade short term whilst trend traders tend to trade long term, so you need to decide what you are more comfortable with; long term time frames or short term time frames. Trends tend to develop over months and not weeks, however a short term trader will be looking at far shorter time frames such as hourly charts. The short term trader would need to be looking at risk/reward goals of 40 pips to make the trade worthwhile. anything smaller makes it very difficult to make profits. Imagine having a target of 10 pips per trade with a 10 pip stop, the bid/ask spread would be around 3 pips so to make 10 pips the trader would have to make 13 pips and the stop would only be 7 pips away. Making profitable trades and producing many pips is very difficult, hence the need for much bigger targets.
When you have decided on the time frames you feel happy with, the next thing on the list is to decide what type of analysis suits you. There are two types of analysis, technical and fundamental. The technical analysts rely on historical data to help them determine where the price action is going, whereas fundamental analysts believe that economic news and announcements are the right tools to determine the price action. Both sets of analysts believe the other is wrong. .
Who’s right? Neither of them, actually. You can’t rely conclusively on one or the other, both are important tools and successful traders use both and do not exclude the other one. However, technical analysis works better on short term time frames and fundamental analysis on the longer term time frames. So again, you need to decide on how much of each analysis you are going to subscribe to depending on the time frames you feel comfortable trading in.
Before you start trading, you should ask yourself what kind of trader you are. It’s not just a question of buying foreign currency and waiting for profits, you have to decide on what time frames and which analysis you are going to work with so that you can trade a style that suits you and no one else.
The concept of currency pairs is one of the most important lessons in CFD trading for beginners. In learning how to trade currencies, the first important aspect of currency trading is to remember that price is meaningless as it’s traditionally understood in the stock and commodity markets.
In the foreign exchange market, the “price” of a currency is actually a rate of exchange between two currencies; or a “currency pair”.
This is one of the foundations for beginning traders that want to understand currency exchange rates in order to learn to trade CFD. The rate of exchange between two currencies consists of the valuation of one currency in terms of another.
Base and Counter Currencies
Even though just about every country on earth has a national currency that is used in international commerce, most currencies trade against the U.S. Dollar, the Euro or some other major currency like the Japanese Yen or the British Pound.
A currency pair consists of a base currency (which is the first currency of the pair) and a counter currency (that is the unit used to purchase the base currency). For example, in the EUR/USD currency pair, the Euro (base currency) is the currency being purchased in U.S. Dollars, which represents the counter currency.
In essence, currency exchange rates represent the amount of counter currency units needed to purchase one unit of the base currency.
You don’t have to worry which CFD analysis is better, just combine the two and trade when both exhibit the same signals.
The CFD market is dominated by a handful of major currencies trading against each other, with the largest and most liquid currencies making up the lion’s share of daily CFD trading volume.
- The United States’ Dollar – the world’s premier reserve currency. the U.S. Dollar dominates the CFD market and is the most heavily traded currency in the world.
- The European Union’s Euro – the common currency for the 17 nation Eurozone is the second most actively traded currency in the CFD market.
- The Japanese Yen – one of the world’s most important economies, Japan’s national currency ranks third in CFD volume.
- The British Pound Sterling – because of the UK’s influence on commonwealth countries, the Pound Sterling is the third most actively traded CFD currency.
- The Australian, Canadian and New Zealand Dollars– commonly called the “commodity currencies”, the currencies of these three nations often react to changes in risk appetite and commodity prices.
The most important currency pairs traded in the CFD market are:
- EUR/USD – the Euro expressed in terms of the U.S. Dollar is the most actively traded currency pair in the CFD.
- USD/JPY – the United States Dollar expressed in terms of the Japanese Yen, is the second most traded currency pair.
- GBP/USD – the Pound Sterling expressed in U.S. Dollar terms.
- AUD/USD – the Australian Dollar expressed in U.S. Dollar terms.
- USD/CAD – the U.S. Dollar expressed in Canadian Dollar terms.
- NZD/USD – the New Zealand Dollar expressed in U.S. Dollar terms.
Currency pairs that exclude the U.S. Dollar are generally referred to as cross rates or crosses.
The most liquid crosses consist of the major currencies other than the U.S. Dollar quoted versus the Euro and crosses containing the Japanese Yen and the British Pound also traded actively.
The trading tools available to you as a newbie trader are numerous and range from the easy to understand and use to the more complex. These tools enable you to analyze market trends, as well as forecast the future price action. However, to use these effectively you need to feel comfortable the with trading platform you finally decide to use to trade in and trust is as a safe environment.
To choose your platform, you’ll need to make sure that there is a dummy trading account available to allow you to spend some considerable time practicing trading online in a safe environment. It’s vital that you learn to trade CFD using a demo account in order to enable you to make the correct decision on what trading platform to use. The CFD demo account works exactly like a live account and displays real time market rates as a live account would and allows you to trade using dummy funds instead of your own hard earned capital.
As with live accounts, the dummy account gives you access to all the trading, technical and fundamental analysis tools and allow you to practice so that you become a better trader and can trade with some success.
There are two types of trading platforms which are available to you through a CFD broker, the most popular is the Meta Trader 4, which is a platform that must be downloaded onto your desktop. This platform provides price charts such as candlestick and line charts, twenty six or so technical analysis tools, Fibonacci, Gann tools and a real time news and economic feed. All these are essential tools you’ll need in order to successfully trade foreign exchange.
The second type of trading platform is the on-line platform. Whereas Meta Trader 4 is visually standardized in look and feel, the platforms which are web based tend to differ in look and feel. Although they do all allow access to integrated charting software as well as integrated technical and fundamental analysis tools, they also offer Fibonacci, Gann software in various degrees. Some web based trading platforms also allow you to see what other traders are trading at any given moment in time and allow you to copy their trades, this is called social trading and by following successful traders you can become successful yourself.
Remember choosing the right platform will give you the potential to become a successful trader.
As with trading in most financial markets, successful online CFD trading usually involves first making good directional decisions based on fundamental and/or technical analysis and then applying sound money management principles to handling the resulting position.
When it comes to establishing a short trading position in the market for a particular currency pair, people who trade CFD have the freedom to sell at any time without having to worry about a short sale rule, unlike stock traders.
To help CFD traders know when to short a currency pair, this article will focus on five bearish signals they can look for to identify a currency pair that is more likely to go down than up.
Tip #1: Look for Bearish Fundamental Indicators and Events
When the base currency’s country is consistently showing poor fundamental economic indicators, such a slowing rate of growth, sluggish or declining employment and declining benchmark interest rates relative to that of the nation issuing the counter currency in a currency pair, then that currency pair is more likely to decline than rise over the medium to long term.
Additional bearish fundamentals for a currency would include: a major disaster, war, domestic financial crisis, scandal or considerable political uncertainty. Announcements of such important events could prompt a sudden short term decline in the relevant currency relative to a stronger currency that is comparatively unaffected by the adverse news.
Tip #2: Look for Bearish Chart Patterns
Technical analysts have identified a series of classic chart patterns that indicate a currency pair is more likely to fall than rise when they appear on the chart of its exchange rate plotted over time.
The following list includes some bearish chart patterns that are considered quite reliable when it comes to signaling that a short position is warranted for a particular currency pair.
Finding any one of these is sufficient to warrant a short position:
- Bearish continuation chart patterns – These include falling flags and pennants, as well as declining channels and overall downward trends.
- An uptrend line or a flat trading range bottom that has recently been broken to the downside.
- Bearish reversal chart patterns – These include ascending wedges, double or triple tops, head and shoulder tops, and saucer tops.
- Bearish engulfing patterns observed on the currency pair’s Japanese candlestick chart.
Tip #3: Look for Bearish Divergence in Momentum Indicators
One of the most reliable bearish technical indicators that would justify shorting a particular currency pair, is when bearish divergence is observed in a momentum indicator in extreme upper territory. Momentum indicators include the Stochastic Oscillator, the MACD and the Relative Strength Index (Also known as RSI).
An example of a bearish signal of this type occurs when a higher high is made in the price, but a lower high is made in the RSI at a time when the RSI is reading in overbought territory above the significant 70 level.
Tip #4: Look for a Bearish Chart Point Configuration
When considering whether a short is justified, take a look at nearby support and resistance levels appearing around the current exchange rate on its chart. If nearby resistance seems especially strong, while support looks relatively weak and distant, then the market is probably more likely to decline.
Tip #5: Look for Strong Selling Interest and Downside Momentum
A short position in a currency pair, seems well justified from a flow perspective when there are considerably more sellers than buyers in the market.
Also, look for bearish situations where the selling interests repeatedly overwhelm the buying interests, thereby resulting in a downward trend without significant upward corrections.
When observing such a down trend, make sure that key momentum indicator like the RSI continue to support the declining price action by showing a series of lower lows.