Having decided on the broad approach you are proposing to take, the next questions you might ask yourself in developing your plan, are as follows:
- Am I going to be a technical trader?
- Am I going to be a fundamental trader?
- Am I going to adopt both approaches and bolt in relational in due course?
Once again, there is no right or wrong answer. As we saw when I introduced these approaches earlier in the book, they have very different underlying philosophies. The central tenet for a technical trader is that the price chart is everything. Within each price, the candle is the views of every investor, trader, and speculator around the world. The price chart is the fulcrum of risk and market sentiment which is displayed second by second before moving on to the next phase of price action, whether on a tick chart or a monthly chart. The price also contains all the news which is absorbed and then reflected on the chart. In other words, the price chart contains and displays all the information about the currency pair in a simple and visual way. Any trading decision is then based on the chart using a variety of technical tools and techniques.
The fundamental approach is entirely different in concept and approach. Here, trading decisions are based on the ‘pure economics’ of the market. The underlying philosophy of the fundamental trader is that currency strength and weakness is determined by the ‘big picture’ data which reflects imports and exports, interest rate differentials, inflation and deflation, economic cycles, employment, housing, retail sales, manufacturing, and a whole host of other numbers, which determine whether a currency is in demand or not. For a fundamental trader, the technical picture is irrelevant, and they will only consider the chart when ready to trade, and as the mechanism by which they open a position. They do not believe in support and resistance, candlesticks, candle patterns, volume, or indeed any other technical indicator. Their analysis of the market is purely based on the economic picture, both at the macro and micro level.
Technical and fundamental traders never agree. Both maintain that theirs is the right approach, and the other is wrong, and here is where I step in.
By all means, investigate both as you will need to understand both, and my advice is simple. If both approaches have value, why to restrict yourself to one or the other – use both! And in my case, I use a third which is the relational element that I introduced earlier in the book.
My own trading has been based on a technical approach, ever since I first started all those years ago. However, I am the first to admit that I pay great attention to the fundamental aspects of broader economics, for many reasons, but for one in particular. Even if you decide ultimately that you are only going to trade using a technical approach, the fundamental news is always there. It dominates this market, and you only have to look at the economic calendar to appreciate why. Every day is full of economic releases, statements, and news announcements from around the world, which will impact the price on release. Therefore, in a sense, you cannot avoid fundamental releases anyway, as one of the decisions you will have to factor into your trading plan is this. Do I trade ahead of the news, through the news, or wait until after the news has been released and the market has reacted accordingly?
In other words, the news is there whether we like it or not, and to simply ignore it would be foolish in the extreme. If this is the case, then even if you ultimately decide that your approach is purely technical, the fundamental will always have an impact, whether in the timing of your decision in opening any new position or simply how it affects the price on the chart. You may decide, as many forex traders do, to ignore fundamental news completely, and simply consider the timing aspect. In other words, check the economic calendar on a daily basis, and note the times when the major releases are due. You can then simply avoid these completely, or manage positions closely during any release.
There are many free sites with good economic calendars which list all these for you and generally for weeks and months ahead. The site I use myself as you know is HTTP:// www.forexfactory.com, but there are others. The common theme with all these sites is that the news is ranked in terms of impact on the market. A red flag indicates an important item which will have a major impact, whilst orange and yellow releases have less significance. In addition, you will also find a wealth of other information, including historical charts for the release, an explanation of the data, a forecast of the expected number, and links to any associated sites or statements.
If you do decide to pay closer attention to the economic news, then this is a big subject in itself, but worth the effort required to understand, what is, in every sense, the ‘big picture’.
In a short book, such as this, it is impossible to give you a detailed view of the fundamental approach, but let me try to build on some of the concepts I introduced in an earlier chapter, which I hope will at least lay the foundations for you. The approach that many novice forex traders take, which I believe is a common sense approach, is to start by learning the technical approach first, and then to build on this knowledge adding in the fundamentals. Economics, after all, is a subject in its own right, and we are not studying to become an economist, just that we have sufficient knowledge to understand why the market has reacted in the way it has, or perhaps how it is likely to react in the future.
Therefore, let me try to give you some broad concepts here, which I hope will help, and the first point is as follows.
No single item of economic news, no matter how important, is likely to reverse a longer-term trend on its own. It will have an impact short term, and the market may reverse sharply on an intraday basis, but looking at the longer term trend, this is unlikely to change, unless the number is reinforcing a longer-term change in the data itself. Let me explain.
Most forex traders will be aware of the monthly release in the US, the Non-Farm Pay-roll. This is a number which always moves the markets, whether the number comes in above, below or at the market’s expectation.
Most forex traders will also simply look at the headline numbers in much the same way as the media since this is a quick and easy way to absorb the information. However, as I mentioned earlier, when you start to look at an economic calendar, such as the one on the Forex Factory site, you will find a historical chart which details all the previous releases going back over the last 12 or 18 months.
If the chart shows a pattern, let’s say of rising unemployment, and the number is positive, with a fall, this alone will not trigger a major change in the longer term trend. It may be the first signal, but on its own, it will not be enough to see any longer-term trend reverse. My point is this – always check how an economic number fits into the trend of the longer term. If the number confirms the trend, then it will continue. If it is ‘against’ the trend, then the market may pause and reverse in the short term, but the longer term trend will remain in place, if and until this data is confirmed, either in subsequent months or by other associated news.
The second broad principle is this.
Economic data from one country will impact all currencies, particularly for major economic powers such as the USA, Japan, and China. China is a classic example and every economic calendar now carries releases, since the economy of China is now so dominant, that any changes here are likely to have an immediate impact on global markets. Chinese data moves every market from equities to currencies, commodities and bonds, and perhaps even more so at present. With the markets generally very nervous following the financial collapse in 2007, any changes in Chinese data are seen as extremely significant and are the ‘hair trigger’ on which markets focus at present. This will change over time but is likely to remain a feature in the short term.
Third and last, and as I mentioned earlier in the book, economic data is cyclical in nature.
In other words, at present, given the ultra-low interest rate environment that exists in the world, these economic releases are far less significant, since this is a feature which is likely to remain in place for the next few years. This will change, but not just yet. As a result, the markets tend to focus on those releases likely to signal expansion and growth for an economy.
This, in turn, will lead to changes in interest rates in due course, which in turn will then become significant once again. It is rather like the leaderboard in a game of golf, or the teams in a football league. Throughout the tournament or the year, teams or players will move up and down the rankings, sometimes they are at the top, and sometimes they move lower – it is the same with the ‘groups’ of economic data. The market focus will change, depending on where the global economy is in terms of expansion or contraction, and the associated inflationary pressures which will then be reflected in related markets.
Now you may be reading this and thinking this all sounds very complicated. After all, we are here to trade and not to be economists or market analysts, which is certainly true and is a very common feeling. There is a great deal to think about when you first start, and my advice here, is always the KISS principle – Keep It, Super Simple.
With simplicity in mind, let me highlight what I believe are the first steps to take when thinking about developing your own approach to a trading plan. The plan is there to provide the foundations of your trading and not the detail. I could even go one stage further and say that it is really there to define the money management aspects of your trading approach, and from which all else flows. After all, if this is not in place, then it is almost impossible to be precise in the other aspects of your plan.