Combining Technical with Fundamental Analysis
“If fundamentals form the brain of the market, technicals give it spirit and soul.”
Fundamental analysis examines the causes behind market movements, while technical analysis focuses on their effects. These two primary methods of analysis are used not only to explain the behavior of financial markets but also to forecast future conditions.
There are three general approaches to trading in any financial market:
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the technical approach
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the fundamental approach
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the combination of technical and fundamental analysis
As Warren Buffett said, “Price is what you pay; value is what you get.”
A fundamentalist focuses on intrinsic value, while a technician concentrates on price movement. A wise analyst considers both.
(1) FUNDAMENTAL ANALYSIS
“Nowadays people know the price of everything and the value of nothing.” -Oscar Wilde, The Picture of Dorian Gray
Fundamental analysis is entirely based on the study of economic, political, strategic, social, and other relevant factors that can influence the future demand and supply of a financial instrument.
A fundamental analyst always focuses on value, and since the relationship between value and price is indirect, fundamental analysis typically requires time for its insights to be confirmed.
The Fundamental Trader
Fundamental traders assess the market dynamics of a basket of financial assets and analyze all economic releases and other relevant information that may impact them.
More specifically:
- Current Macroeconomic Conditions in Relation to the Macroeconomic Circle
- New Economic Data (majorly Inflation, GDP, and Unemployment Rate)
- Political Risks and Social Conditions
- Interest Rates
- Other Monetary Policies
- Central Bank Interventions
The Time Interval
Fundamental analysis is especially important for long-term traders and is largely irrelevant for short-term traders.
There is an exception to this rule: news traders. These traders open and close positions within the same day, focusing exclusively on key fundamental releases. In other words, they apply fundamental analysis to short-term trading.
Fundamental Changes Offer the Best Trading Opportunities in Life
A shift in major government policy or the release of unexpected macroeconomic data can completely overturn a fundamental forecast. During such key changes in the macroeconomic environment, price swings in financial instruments can be extreme. In these rallies, there is no room for correction or consolidation. As a result, when significant fundamental changes occur, fundamental analysis becomes the dominant tool, while technical analysis appears ineffective.
The most profitable trades often happen shortly after major political or economic announcements. The key advantage of trading fundamental changes is the strength and clarity of market trends—sometimes yielding 3,000 pips within just a few days. Moreover, because the market often takes time to fully interpret fundamental changes, traders have the opportunity to enter at the early stages of strong movements. Finally, by using a trailing stop order to exit, you can ride the trend to its limits while securing your profits along the way.
→ Enormous price swings
→ Time to enter the price movement at its early-stage
→ No corrections, no price consolidations
→ Huge Reward/Risk ratio
→ Trailing-stops work ideally, as the market moves straightforward
🗳️ The Case Study of the 2016 American Elections
Before the 2016 U.S. elections, the expected winner was clearly Mrs. Clinton. Bookmakers offered odds of 1.2 for Clinton and 5.0 for Trump—implying an 80% chance of victory for Clinton and only 20% for Trump.
The Market Anticipations Were Not Based on Hard Fundamentals
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Most currency analysts believed that a Trump victory would cause the U.S. Dollar to collapse.
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In reality, Trump had expressed support for a strong dollar policy.
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Most stock market analysts predicted that a Trump win would crash U.S. stock markets.
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In reality, Trump aimed to cut corporate taxes, which would boost profits and dividends for shareholders.
There was a clear divergence between market expectations—as reflected by leading analysts—and actual fundamentals.
What Happened Next
In the hours following Trump's election, both the U.S. Dollar and U.S. stock markets dropped sharply, driven by market psychology and fear of the unknown.
However, within days, both the U.S. Dollar and stock markets rebounded and reached new record highs. This reversal occurred because hard fundamentals ultimately prevailed. They always do.
(2) TECHNICAL ANALYSIS
“People create the market, and since human behavior tends to repeat itself, the market also moves in repetitive cycles.”
Technical analysis is a method of studying and interpreting mass behavior through the use of charts, trends, and historical price data. In practice, technical analysis aims to assess market conditions and forecast future price movements.
The Computer Revolution and Derivatives Created Volatility and 'Shorterism' in the Market
In 1981, IBM introduced the first personal computer. By 1983, Mr. Mendelsohn released the first retail back-testing and optimization trading software for the IBM PC, called ProfitTaker Futures Trading Software. Since the early 1980s, technical analysis has grown rapidly in popularity. The advent of personal computers (such as the IBM XT and Apple Mac), along with the rise of trading software, enabled retail traders to perform technical analysis from small offices—or even at home.
In parallel, the growing popularity of the derivatives market made financial trading significantly more volatile and short-term focused.
These developments created a strong demand for a tool capable of analyzing short-term market behavior—and there is no better tool for that purpose than technical analysis.
📝 The Major Assumptions of Technical Analysis
These are the five (5) major assumptions of Technical Analysis:
1. Information is already incorporated in the current prices
2. Prices are moving in trends
3. Price movements are usually not random
4. Historic trends are usually repeated and create price patterns
5. There is no particular time-frame you must trade the market
The Technician Trader
A technician believes that price moves in trends, and that these trends tend to repeat. Technicians aim to identify specific price formations and make trading decisions based on historical price data. In technical analysis, history plays a crucial role.
💱 The Six (6) Categories in Forex Technical Analysis
Technicians use a wide range of charting tools, including support and resistance levels, major trendlines, indicators, oscillators, pivots, chart patterns, and more. These tools fall into six main categories in Forex technical analysis:
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Number Theories (mainly Fibonacci and Gann numbers)
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Wave Theories (Elliott Wave Theory and Harmonic Patterns)
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Indicators and Oscillators (MACD, RSI, ADX, etc.)
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Chart Patterns and Candlestick Patterns
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Price Gaps (High-Low, Open-Close)
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Moving Averages (mainly Simple and Exponential MAs)
Trend-following indicators help traders identify strong trends (e.g., MACD, MAs, ADX). Oscillators assist in spotting potential price reversals (e.g., RSI, Stochastic, Force Index).
These are some major technical analysis tools:
- Moving Average Convergence Divergence –MACD (Identifying trends)
- Relative Strength Index –RSI (Triggering reversals -30/+70)
- Average Directional Movement Index –ADX (measuring the strength of the trend)
- Gann Numbers (Price / Time Equivalents, primary Gann angles are: 1X2, the 1X1, and the 2X1)
- Fibonacci Ratios (mainly 0.618, 1.618, 0.382) –Find more here: Tradingfibonacci.com/index.php/fibonacci-trading/fibonacci-sequence
- Gaps (an up price gap is considered a sign of market strength, and a down gap is a sign of market weakness)
- Elliott Wave Theory (5-wave advances followed by 3-wave declines) –Find more here: Tradingfibonacci.com/index.php/fibonacci-pattern/elliott-wave-patterns
- Harmonic Patterns (ABCD formation) –Find more here: Tradingfibonacci.com/index.php/fibonacci-pattern/harmonic-trading
(3) Combining Technical and Fundamental Analysis
Many of us believe that the most effective way to trade Forex or any other financial market is by combining technical and fundamental analysis.
Balancing the Two Methods in Our Decision-Making
Depending on the timeframe, strategy applied, and current market conditions, there are times when either fundamental or technical analysis may become less relevant.
Table: The importance (weight) of technical and fundamental analysis across different strategies
|
MARKET CONDITIONS / STRATEGY |
TECHNICAL ANALYSIS |
|
Key News Releases |
Irrelevant |
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Fundamental Changes |
Irrelevant |
|
Long-Term Trading |
10% |
|
Carry Trading |
30% |
|
Swing Trading |
50% |
|
Intraday Trading |
70% |
|
Scalping |
100% |
⚠️ Don’t Underestimate Any Form of Analysis
You must never underestimate either fundamental or technical analysis.
Here’s why:
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If you ignore fundamental analysis, you’ll end up trading only prices and lose sight of the true value behind your assets. Avoid this mistake in the long run, or you risk losing all your money.
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If you overlook technical market conditions, you’ll miss the market sentiment entirely. This is a critical error in the short term. Understanding market sentiment is essential, whether you choose to follow it or not. What the market thinks is valuable information.
Seeking Confirmation
In the long term, new fundamental conditions must align with key price trends.
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Bullish fundamental changes should be accompanied by bullish technical indicators to be confirmed.
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Bearish fundamental changes should be followed by bearish technical indicators to be confirmed.
In other words, when fundamentals and technicals align and confirm each other, a successful trade is born.
🔚 Final Conclusions
Technical analysis studies price, while fundamental analysis studies value. As a general rule, technical analysis is more effective in shorter timeframes due to the lack of significant fundamental changes. In longer timeframes, fundamental analysis reigns, as market sentiment follows the actions of large players. In any case, never underestimate either of these two major market forces. Most professional traders combine both approaches to achieve superior results. If you cannot combine them, it is better to become a fundamentalist and trade long-term. Trading solely short-term as a technician is much more demanding than most traders realize and is better avoided.
Personally, I see technical and fundamental analysis as two essential components of a successful trading system, with money management as the third. Here’s how it works:
→ Use fundamental analysis to decide what to buy
→ Use technical analysis to decide when to buy
→ Use money management to decide how much to buy
As I see it: “If fundamentals create the brain of the market, technicals create its spirit and soul.” For a successful and balanced trading career, you need both brain and spirit.
■ Forex Forecasting Methods: Technical vs Fundamental Analysis
George M. Protonotarios, November 2016
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