The
Great Debate: Fundamental vs. Technical Analysis
One of the dominant debates in financial market
analysis is the relative validity of the two major
tiers of analysis: Fundamental and Technical.
In Forex, several studies concluded that fundamental
analysis was more effective in predicting trends
for the long-term (longer than one year), while
technical analysis was more appropriate for shorter
time horizons (0-90 days). Combining both approaches
was suggested to be best suited for periods between
3 months and one year.
Nonetheless, further empirical evidence reveals
that technical analysis of long-term trends helps
identify longer-term technical "waves,"
and that fundamental factors do trigger short-term
developments.
Let's take the declining USD/JPY exchange rate
in 1999 as an example. The pair lost 16% in the
second half of the year, reaching a year low of
101.90. Both fundamentals and technicals alike
could explain the downward move. Fundamentals
attributed it to the continuous capital inflows
into Japanese assets, which reflect investors
increased optimism with the Japanese recovery.
Technical analysts were likely to explain the
move with the simple argument: the language of
the market voiced a clearly downward tone that
became more resounding after the breach of key
technical landmarks (115 yen and 110 yen).
Thus, both technicals and fundamentals reached
the same conclusion. However, fundamental analysts
with a technical blind spot risk missing key market
turnarounds after the breach of an important support/resistance
level.
Conversely, a technically inclined analyst with
a disregard for fundamentals and news releases
would have missed the rebound in EUR/USD, which
was triggered by the release of a stronger than
expected German business sentiment survey (IFO)
in July 19, 1999. Up to that point, the euro had
lost 15% reaching an all time low of $1,010. Most
market observers—fundamentals and technicals
-were predicting the euro to break below $1.00.
Technical analysts stated psychology, momentum,
and moving averages as arguments for further downfall.
But fundamentally inclined analysts who paid attention
to the strong survey would have been able to promptly
exit their long dollar positions in favor of the
euro. On that day, the euro jumped 200 points
against the dollar with an additional 260 points
on the following day, and an extra 150 days in
the third day. In just two weeks, EUR/USD soared
by more than 800 pts.
Obviously, the IFO survey release was not the
single reason behind the euro's 7% rebound. Other
factors over the subsequent weeks also helped
prop the currency. These included a broadening
improvement in economic fundamentals throughout
the Eurozone and increasingly hawkish stance (favoring
higher interest rates) from the European Central
Bank. Nevertheless, the release of the IFO survey
was the turning point in shifting expectations
of the euro.
It has been often stated that combining fundamentals
with technicals was counterproductive. Owing to
their contrasting types, technical and fundamental
analysis are often said to be mutually exclusive.
Yet, a large number of traders combine the two
approaches, even instinctively. Thus, technically
inclined traders do pay attention to central bank
meetings, give consideration to employment reports
and heed the latest inflation numbers. Similarly,
fundamental traders are often trying to figure
out the major and minor levels of support, and
determine the percentage of retracement formations.
There does not exist a specific formula for figuring
out the optimum approach of combining fundamental
and technical analysis in the Forex market. Some
computer software packages claim to be able to
make such decisions, weighing one approach against
another depending on economic, technical and quantitative
parameters. Yet, these are based on models from
past patterns of inter-market dynamics and previous
technical and fundamental behavior. The FX market
is too dynamic for such pre-formed frameworks.
|
Forex News &