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Our guest article from Jennifer Gorton, of Forex Traders, gives an insight into the world of currency trading.

Fundamental and Technical Data Can Be Synergistic if Used in Tandem

There are two different types of investors in this world, the ones who prefer to “buy-and-hold” and look to the long-term horizon, and those who prefer a more active trading style that focuses primarily on short-term gains.  Each camp also has its own style of analysis, the former analyzes the fundamentals, and the latter depends on technical analysis to guide their market entries and exits.  Although each camp religiously argues on behalf of its constituents the merits of its respective style, some still view fundamental and technical analysis as oil and water.  The simple fact is that each tool can complement the other on several occasions when investing in today’s global markets.

A “value investor” typically has a long time horizon, while an active trader wants a shorter one.  However, a different perspective is necessary to recognize the synergy between the two analytical methods.  We can view “fundamentals” as the reasons why supply and demand forces operate in a market, and accept technical analysis as a useful tool for observing these market forces in graphical form.  Market forces, like every other force in the natural world, behave like waves, ebbing and flowing, as they seek equilibrium.  Price movements never move in straight lines, but in choppy zigzags that represent trends and patterns that often repeat.

Currency trading, a popular form of alternative investment, actually uses both disciplines in tandem to discern profit opportunities in the forex market.  The “AUD/USD” chart below is one example that illustrates the complementary aspects of these two analytical modalities.

Forex chart

Australia has been a quiet economic success happening down under for the past several years.  While other G10 countries have struggled with the global recession, high unemployment and ineffectual monetary policy, Australia has been growing for the eighteen months following the Lehman Brothers failure in 2008.  GDP was up 2.7% in 2009, and has grown another 2% over the first half of 2010.  Unemployment is half of what other countries are experiencing, investments in production capacity are steady, and China’s demand for raw material exports, though moderated, continues unabated. 

Strong Aussie fundamentals have created a prolonged run up of their currency for the past five years.  Forex traders have benefited handsomely from these long-term trends, even on a short-term basis by using a common trading method, generally referred to as “time framing”, to support their trade execution.  A trader will take his preferred trading period chart and review for potential trends before making his decisions for the day.  If he spots a pattern or trend, he will adjust the timeframe of his chart by multiple hourly increments to determine if the trend aligns with the general path of the currency over a longer term.

Currency markets tend to react to every headline and are ultimately shaped by trader psychology, but traders that understand forex discount or weight some news more than others.  Although news related to debt problems in Greece began to surface in late 2009 and then expanded their scope in February, the severity of the crisis was not fully recognized until May.  A crisis is a basic fundamental whose impacts are unpredictable.  Its effects can easily overshadow the ability of healthy economic data to influence current pricing behavior.

Risk-averse capital, anticipating a disaster, began to seek safe havens, primarily in U.S. Treasury Bills and precious metals.  Forex traders, employing a long-term “carry trade” strategy, had sold the greenback and gone long on the “AUD”, thus profiting from the difference in interest rate spreads between the two countries and the appreciation of the AUD.  Traders unwound their positions.  The Aussie Dollar ran into resistance and formed a “triple top”, a technical signal that a decline was imminent.  The RSI indicator was also signaling an “overbought” condition, another technical message that a trend reversal was about to happen.  Once again, a wise trader that assimilated both fundamental and technical information was in a position to profit from future expectations.

Lastly, a crisis may cause a “jerk” in the normal wave patterns formed by fundamentals in the market, but eventually, fundamentals will prevail in market valuations.  The United States has done little to reduce its debt or deficit problems.  Its economic recovery has stalled.  On the other hand, Australia is still in growth mode.  The “bounce back” of the Aussie Dollar, following the May shockwave and driven by economic fundamentals, was a predictable event waiting to happen.  Today’s valuation was $0.9441, a return above the original triple-top.

For both long and short-term investors, the “trend is my friend”.  Discerning trends on a consistent basis leads to successful investing no matter what the timeframe.  Prudent investors understand this principle and take advantage of every edge provided by both fundamental and technical information alike to win in today’s turbulent marketplace.