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There are two major schools of thought when it comes to analyzing the financial markets: technical analysis and fundamental analysis. Moreover, the fundamentals are often less favored than technical analysis in these discussions. That’s probably why nearly every forex trader you meet is more likely to depend on technical indicators, not the fundamentals.
However, another big reason is that most traders want to go for the quick win. They prefer that over playing the long game.
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Technical Analysis and Quick Returns
Traders who favor technical analysis study past price history in order to predict future price action. They take into consideration the volatility in the currency markets, of course. And they leverage their trades to maximize their profits.
Therefore, many traders focus on building a trading system based on automation. That is, they take advantage of technical analysis to maximize really quick returns from forex trading.
The Problems with Fundamental Analysis
Meanwhile, they often relegate the fundamentals to the background. Most traders do this because they consider fundamental analysis to be complex. They don’t want to take the time to understand the fundamentals, so they just ignore them.
However, there are traders who do take the time study the factors behind the behavior of forex prices in the market. These traders understand that learning about the fundamentals gives them a long-term advantage.
These traders also understand that the markets are irrational most of the time. They know that because of this irrationality, technical analysis can appear to make more sense, especially to day traders.
The Fundamentals as They Apply to Long-Term Investing
However, traders in the stock market more often look to the fundamentals. This is probably because most investors in the stock market are long-term investors. That is, they’re looking for long-term gains with their 401k plans and so on.
Also, Warren Buffet, one of the most respected investors in the world, stresses the use of value investing and focuses on the fundamentals.
The Basics of Fundamental Analysis
It’s good to remember that just as the fundamentals are essential for investing in the stock market, they can give you an edge in the forex market, too.
This is basically because learning about fundamental analysis will give you the freedom to begin to forming your own opinions about the markets. You’ll even find that sometimes your opinions will be far different from those of other traders. This can give you a big advantage.
Here are some of the basic concepts of fundamental analysis to help you to get started. Right away, you’ll see that these concepts are just common sense.
1. Buy the Rumor, Sell the News
This is a phrase that every forex trader has heard at some point. However, if you think about it, you’ll see that often the markets behave in ways the policymakers least expect. And when there is a big disconnect between expectation and outcome, you can gain an edge with your contrarian opinion.
2. Look at the Longer-Term Trends
The fundamentals often hit the headlines for the wrong reasons. For example, a recent US jobs report just made big headlines. If you read that news release without considering the larger context, you might think that the US economy had just tanked. However, the long-term trends will give you better insights.
3. Everything Is Interrelated
In short, what happens in Asia affects Europe, the US, and other markets. Therefore, fundamental analysis can help you to anticipate what’s coming next. For example, when the Chinese stock markets take a tumble, US stocks take a hit as well.
You might think the three points we discuss here are trivial. However, if you apply them properly, you’ll gain insights not possible otherwise. Basically, the fundamentals can give you a real edge in the markets.
And if you want to know the real secret to understanding the fundamentals, it is this: Learn to trust your own analyses. With practice, you will eventually get this right.