When Fundamental and Technical Analysis Align

trading strategy when fundamental and technical analysis align

The FX market is the most liquid of financial markets with a plethora of diverse participants each with their own strategy developed for benefiting from the inherent fluctuation and volatility. The two most commonly known approaches, and the subject of this article, are fundamental and technical analysis.

Fundamental or Technical Analysis?

Traders basing decisions on fundamental analysis focus on economic data, events and sentiment in order to derive a bias that will provide them with an ‘edge’. A fundamentalist will consider an economy’s GDP, inflation, capital flows, and interest rates amongst other things to attempt to put a value to a currency. There a numerous successful traders that base decisions on the underlying economics and perceived value. However, despite the clear benefits of understanding what may be driving the price of a currency, traders adopting technical analysis disregard fundamentals as an educational pursuit by a person more interested in being right than making money. On the flipside, technical analysts focus there attention on price, whilst incorporating tools such as support and resistance and trend-line analysis. Traders basing their decisions on technical analysis care little for the underlying driver of price, but understand how to react to the volatility.

Each school of thought, though different, has equal value and can be the basis for a successful trading strategy. After all, some of the biggest and most successful funds are technical or fundamental based, so there is no disputing the value of each one. Essentially the sole purpose of a trader is to generate profit from the market, how, is not important, but your P&L is.

The purpose of this article is to highlight a specific trade in which the fundamental and technical analysis drew the same conclusions demonstrating how beneficial an understanding of both concepts can be. After reading this article your bias towards either approach will not have changed, but we may have opened your eyes to the potential of making decisions based on both.

Eur/Nzd trade analysis example

Between January 10th 2011 and March 7th 2011 Eur/Nzd has rallied from 1.6931, to a high of 1.9002, an unbelievable 2071 points in 2 months. This pair moved close to 74% of the entire 2010 range in the first quarter of this year. The power of making trading decisions based on both fundamental and technical analysis could not be more evident than in this trade - here is the break down.

trading strategy EUR NZD trade strategy

After a period of tepid, but gradual expansion from 2009 to the end of 2010, the New Zealand economy produced a negative growth figure for the 3rd quarter, and fears of recession came to the forefront again. Whilst the New Zealand Economy struggled to expand the RBNZ raised interest rates by 50bps exacerbating the slow down further. With a commercial and residential property market in a downtrend it seemed the RBNZ were premature in tightening monetary policy. On top of a fragile economy the country was shook by a devastating earthquake that could potentially, according to some analysts, shave 1% off GDP figures for this year. The fundamental picture for the New Zealand economy is one that is on the edge of recession, hit by natural disaster, and in desperate need of both fiscal and monetary support.

From the fundamental state of the New Zealand economy it was a straightforward sell signal, the next step was to identify an off-set currency. With the Eurozone showing signs of improvement, and without a sovereign debt crisis of a peripheral nation in the headline, analyst began focusing on the higher inflationary pressures stemming from the rising commodity prices. It is no secret that the ECB has a mandate that prioritizes price stability before anything else, and with inflation above their target range it was a matter of when, not if Chairman Jean-Claude Trichet would produce a hawkish statement in relation to interest rate hikes. Despite the divergence in economic prosperity between the stable German economy and the peripheral nations, traders used this opportunity to begin pricing in an interest rate hike. The decision to buy the Eur/Nzd was fundamentally based on the contrasting situation they faced.

From a charting perspective the uptrend is self-evident. After spending the best part of the last two years in a strong downtrend, the Eur/Nzd bottomed out at the 1.6900 level. After a brief relief rally up to the 1.7500 level the pair then continued its downtrend only to be halted at the 1.7150 number thus forming a higher low. A few days later a new higher high was formed breaking the previous high at 1.7500 officially confirming the new uptrend. On a break of this level the pair rallied aggressively before entering a period of price consolidation where the other market participants gradually accepted the new direction for the pair and started buying into Dips, pushing the pair to further highs of 18040, 1.8491, 1.8687 and finally the most recent high of 1.9020. This price action indicates strong positive sentiment towards the Euro which is in stark contrast to the extremely negative sentiment held towards the New Zealand Dollar.

The debate over fundamental versus technical analysis will be on-going and disputed. As mentioned earlier, each approach carries its own merits and is implemented with equal success. However, I am confident that there is little argument that when both views are aligned, not only are the chances of success dramatically increased, but the intensity and conviction of the move can lead to significant profits in relatively short period of time.

Alex Ong & Nicky Ong