Combining Technical and Fundamental Analysis in Forex Trading

Video Tutorial: How To Combine Technical & Fundamental Analysis

Introduction

Understanding how to combine technical and fundamental analysis can significantly enhance your trading strategy. These two methods provide different insights, much like how a spoon and a fork are designed for different types of food. Using them correctly together can give you a well-rounded approach to trading.

What You'll Learn: This guide will show you how to effectively integrate these two forms of analysis and apply them in a real trading scenario.

Understanding Technical and Fundamental Analysis

Technical Analysis

Technical analysis involves using historical price data, charts, and various indicators to predict future market movements.

Tools Used:

Support and resistance levels
Moving averages
Chart patterns

Fundamental Analysis

Fundamental analysis focuses on evaluating economic indicators, financial statements, and macroeconomic factors to determine the intrinsic value of an asset.

Key Factors in Forex:

Interest rates
Employment data
Geopolitical events

Using Fundamental Analysis to Determine Trade Direction

Fundamental analysis helps you identify which currencies are strong and which are weak. By evaluating macroeconomic data, short-term sentiment, and intermarket analysis, you can form a bias about the direction of a currency pair.

Example: If you expect a central bank to cut rates, that currency might weaken, while a currency from a country with rising interest rates might strengthen.

Align Short-Term and Long-Term Views

However, predicting a central bank's actions doesn't mean you should trade immediately. It's essential to align short-term sentiment with the broader macroeconomic view.

Key Principle: If the short-term sentiment supports your fundamental outlook, it's a good time to trade.

Using Technical Analysis for Precise Entry and Exit Points

Once you've identified the trade direction using fundamental analysis, use technical analysis to find precise entry and exit points.

1. Determine the Trade Direction

Use fundamental analysis to identify which currencies are expected to strengthen or weaken. This gives you the direction for your trade.

2. Identify the Optimal Entry Point

Use technical analysis to find high-probability entry points. Look for support and resistance levels, moving averages, or chart patterns that confirm the direction indicated by fundamental analysis.

3. Set Stop-Loss and Take-Profit Levels

Based on technical indicators, set your stop-loss and take-profit levels to manage risk and lock in profits.

Complete Trading Strategy Example: JOLTS Job Openings

Step 1: Analyze Federal Reserve Priorities

The first step is to understand what data points the Federal Reserve is currently focused on. If the Fed is focused on a particular piece of data, that data point will have significant volatility because the Fed bases its interest rate decisions on it.

Professional Tool: To quickly determine the Fed's current focus, use a Professional Economic Calendar with a fundamental guide. This resource helps traders stay updated on the data points that matter most to the Fed, providing a strategic advantage.

Step 2: Use High-Low Expectation Forecasts

Professional traders rely on high-low forecasts to gauge market expectations accurately:

Institutional Forecasts

Professional economic calendars include high and low estimates from top institutions. This broader range of expectations offers a more comprehensive picture of potential outcomes.

Market Shocks

When a report exceeds the high estimate or falls below the low estimate, it's a huge shock to markets because no analyst expected it. Such deviations often result in sharp market movements.

Lightning Bolt Feature

This tool immediately signals a deviation above the high or below the low of analyst expectations. When a deviation occurs, the lightning bolt feature alerts traders instantly, allowing them to act without delay.

Understanding High-Low Forecasts

Economic forecasts are derived from surveys of credible institutions, each providing their best estimate on upcoming data points. Retail calendars typically present the median of these estimates, which can be misleading.

Key Insight: The median forecast doesn't reveal the full range of expectations. Professional economic calendars include both high and low estimates, showing analysts' expectations at the extreme ends. Great trading opportunities arise when data releases fall outside these high and low estimates, creating market shocks that move prices significantly.

Step 3: Choosing the Most Volatile Instrument to Trade

Using insights from institutional reports, traders can select the most responsive currency pairs. For example, if USD/JPY is particularly sensitive to economic data and JOLTS shows a significant deviation, this pair could be an ideal target for trading.

City Economic Surprise Index

This report identifies currency pairs that react strongly to economic surprises. It highlights pairs that are sensitive to data deviations, helping traders focus on the most responsive markets.

Risk-Reversal Report

This report shows market positioning, revealing a buildup of call or put options on certain currency pairs. Understanding these positions helps traders choose a pair that may have orders susceptible to getting liquidated upon the release of an economic data point.

CFTC Report

This report details hedge funds' positions. For example, if many big players are long the EUR/USD but then data comes out in favor of the USD, some of those funds might have to unwind their positions, leading to an outsized move.

Trade Execution Steps

1. Confirm Fed Focus

Ensure the Federal Reserve is currently emphasizing employment data. If employment is a primary focus, the JOLTS report will likely move the market. Remember, if the central bank is focused on a data point, it's because they use that data point to make decisions on rates, leading to volatility.

2. Check Forecast Ranges

Before the data release, review the high and low forecast expectations for the event. Plan to trade only if the actual data significantly exceeds the high estimate or falls below the low estimate. This strategy ensures you act on genuinely surprising data, likely resulting in follow-through reactions.

3. Monitor Revisions

Check for any conflicting revisions in the data, as these can alter the initial market reaction. Make sure the primary release and any revisions align to support your trade.

4. Enter Trade Promptly

Once you confirm the deviation, act quickly to enter your trade. Enter within the first 30 seconds. Speed is crucial, as market reactions to significant data surprises happen rapidly.

5. Set Stop and Take Profit

Stop-Loss: Place your stop-loss below the low of the initial spike candle to protect against adverse movements
Take Profit: Aim for 15-30 pips for tier 2 events like JOLTS, adjusting based on market conditions and volatility

Managing the Trade

After the Initial Run

Look for a shallow pullback around a 23% Fibonacci retracement or near support/resistance levels. This initial pullback can provide an opportunity to enter the trade again after taking some profits from your first entry.

Break Even

Move your stop-loss to break even as soon as possible to protect your gains. In general, the stronger the release, the shallower the pullback. If the market doesn't buy off your S&R level and continue to the highs of the one-minute candle and break, something could be off.

Reentries

If your initial position is stopped out at break even, consider reentering at deeper retracements, such as the 38% or 50% Fibonacci levels. Use nearby support and resistance levels to guide your reentry points.

Conclusion

Combining technical and fundamental analysis can provide a comprehensive approach to Forex trading. Use fundamental analysis to determine what to trade and in which direction. Then, apply technical analysis to pinpoint precise entry and exit points.

Key Takeaways

Use fundamental analysis to determine trade direction (which currency to trade)
Use technical analysis to find precise entry and exit points
Align short-term sentiment with broader macroeconomic view before trading
Confirm Federal Reserve priorities before trading economic data releases
Use high-low forecasts to identify genuine market surprises
Look for support/resistance levels and chart patterns to confirm fundamental direction
Set stop-loss and take-profit based on technical indicators
Use Fibonacci retracements for trade management and reentry opportunities

Final Note: This strategy ensures you're trading in line with broader market trends while optimizing your entries and exits for better profitability. By following these steps, you'll be well-prepared to trade effectively, leveraging the same strategies that professional traders use.