Peculiarities of fundamental and technical analysis in Forex: traps, errors of beginner traders; how to avoid trading mistakes.
Many newbies may think that fundamental analysis is a simple tool to earn easy money: you just need to wait for good news and enter a trade in the trend direction. They are much disappointed when the price reverses in the opposite direction. Something like this happens to the fans of technical analysis. The main reason is underestimating of complexity of these types of analysis. You will learn from this review about pitfalls of fundamental and technical analysis as well as how to avoid common mistakes. At the end of the article you’ll find some useful for trading links!
The dangers of fundamental and technical analysis
Fundamental analysis is the most appealing for novice traders. It is logical. You don’t have to study the special features of indicators, if you can earn, for example, on the publication of positive statistics, reporting, or invest in top companies like Alphabet, Apple – their stocks grow in price anyway. What a surprise it is when the price goes in the opposite direction or swings up and down triggering stop losses. At this moment, they suspect that the broker falters with quotes. Alas, it is human nature to blame anyone for mistakes, but not yourself. Although the case is mainly in the trader, who did not take into account any factors.
The same is with technical analysis. False signals from indicators are charged to the fact that the quotes are late or the broker is again to blame. For some reason, the fundamental factor is not taken into account. This review will briefly describe the traps of fundamental and technical analysis, which for some reason are not taken into account by beginners. Advanced investors know all of this, so, first of all, the article will be useful for newbies. Easy money does not come!
Traps of fundamental analysis
Fundamental analysis can be roughly divided into three parts:
- Analysis of geopolitical and macroeconomic factors: GDP and labor market, monetary policy of the Central Bank (discount rate, control of the money supply, etc.), statistics, balance of payments, trade relations, emergency events, including local military conflicts.
- Analysis of individual industries: growth dynamics in percentage terms, outlook, level of demand, etc.
- Analysis of individual companies: financial performance.
1. Failed expectations
Here, the most appropriate example is the stock market. One of the common strategies of to make profits on the stocks is to enter a trade at the time of publication of statistical data: financial statements, results of work done (for example, biotech companies are particularly sensitive to the failure of medical research tests), expansion to local markets, etc. It sounds reasonable "Positive financial statements - rising stock value." It is a common mistake of novice traders who forget that any statistics is viewed in dynamics.
This chart shows two major price drops, which turned out to be the deepest since 2012. March 16, Facebook's stock price fell by 6.8%. The reason was information that the personal data of 51.3 million social network users were stolen, published in the media.
Note. This is a good example of how the price reacts to all sorts of positive and negative comments. A sharp crash in prices suggests that investors are massively selling Facebook stocks. And now pay attention to how much you could earn by buying stocks when the price was reaching the low: within 4 months, the price rose from $ 153.03 to $ 217.5. An excellent proof that you should never panic: do not sell during the price fall, buy at the very low.
But we are interested in the second price drop. Pay attention to how vertical and fast it is. On Wednesday, July 25, Facebook stocks dropped by 24% immediately after the main trading sessions in the US closed. The reason is the publication of financial reporting:
- The company revenues for the quarter increased according to the report to $13.2 billion, although it had been expected to grow to $13.3 billion;
- The growth rate of the monthly audience for Q2 was at 1.54%, compared to 3.14% in the first quarter.
- The number of daily active users was +1.44% in Q2, compared to +3.42% in the first quarter.
- The number of users in Europe decreased to 376 million from 377, it was without any changes in the North America (241 million of people).
As you see the company’s financial performance in the second quarter was positive: there is a growth, the revenue increased. But, compared to the previous quarter, it was less, which resulted in that strong price fall.
How to avoid the trap:
- Analyze financial statistics for several periods, comparing it with the expected data (for stock markets). Assess industry reports for several periods.
- Monitor analytics and forums. But be careful, as manipulations are also possible.
- Diversify risks. Errors are inevitable and profits must cover the losses. It makes sense to invest in directly correlated assets.
I also want to mention such a phenomenon as Ex-dividend. It occurs on dividends on stocks are to be paid. It would seem that on the eve of the payment you can buy more shares, receive dividends and immediately sell them. Greedy beginners often fall into this trap.
Dividends are paid to the shareholders. Dividend payment is agreed at the shareholders' meeting, where the corresponding register is formed and the date of payment is determined (the so-called cut-off date for holders). Everyone who is a security owner on the next morning after the cut-off date receives dividends. Ex-dividend describes a stock that is trading without the value of the next dividend payment. The ex-dividend date or "ex-date" is the day the stock starts trading without the value of its next dividend payment. Ex-dividend describes a stock that drops in price by an amount approximately equal to the dividend amount, because they are paid at the expense of the company's profits. By the way, you can’t enter a short trade (since you already know that the stock price will fall by the amount of dividends), it is this is prohibited, and the broker must forcibly close such a position.
Decide on your own if the Gazprom PAO share price drop is the ex-dividend or just a coincidence.
2. Underestimation of other factors
The Fed discount rate and report on the US employment are thought to be one of the most influential factors for currency pairs that include the US dollar. As well as a report on the US oil reserves, gasoline stockpile and the number of shale oil drilling rigs. At first glance, this could be an efficient strategy. For example, at the time of positive reporting on the labor market is published one might open a long position lasting about an hour. But this does not always work. Even despite the growth in jobs number, it is necessary to analyze data on unemployment, changes in average hourly wages, etc.
I will give another example: the EUR/USD exchange rate depends on not only the US economic data, but on the ECB reports as well. If the first data have been already anticipated by investors and coincide with their expectations and the ECB statistics turns out to be unexpected (doesn’t match the forecasts), then the ECB statistics, thought to less influential than the US economic reports, will outweigh and support the EUR value.
How to avoid the trap:
- Assess everything in the complex, ranging from geopolitics and macroeconomic indicators, ending with industry data and statistics of a single company. Estimate the central bank policies in all the countries as well as economic statistics to trade In the foreign exchange market.
- Analyze the industry state in general.
- Do not hurry. If the price for some reason has gone in the opposite direction after the statistics release, you’d better close exit the trade and wait. On December 6, 2013, after the release of a very strong NFP report, the EUR / USD rate declined, but then the trend reversed. According to analysts, such a reaction to a strong positive report was the first time since 2000. Nobody knows why. It is possible that large investors played against the market.
3. Late response to an event
Suppose you are expecting an event: a change in the discount rate or a financial report. You buy (sell) an asset, but ... Statistics is published, and the asset price does not change and you lose money due to margin. Why this happens: the matter is that many events are predictable long before they occur. And more long-sighted traders buy an asset much earlier. Analysts say like this: the price of the asset did not change, since investors had already “traded” the news.
How to avoid the trap:
- There is a single solution: learn to consider different scenarios in advance and keep the two above points in mind.
4. Manipulations by means of the media
Where would you search for information about a particular event? Will you study economic calendar, original sources or the media, forums, analytics, expert opinions? Of course, there is little trust in experts and the media, but when the same information is confirmed in different sources, and it is also actively discussed in topical forums, you unwittingly start believing the majority. But there is a reasonable question: if, for example, everyone wants to buy an asset, then who will sell it at a price rise? Market-makers? Or those who deliberately created the right informational environment, encouraging potential investors to take the needed decision?
There a few ways how the “trading sharks shear sheep”:
- Manipulation with figures. The statistics is presented in a way to create a certain, needed by the manipulator, opinion about situation. Most often it is convenient to influence people’s opinion, indicating percentage points. Few people think from what the percentage and in comparison with what.
- Creating fake accounts on the forums to make it look like chatting in order to introduce particular ideas in trader community.
- Special "stuffing" of deliberately false news, ideas, opinions through their hired analysts.
How to avoid the trap: read more about such manipulations and the ways to protect you here.
Traps of technical analysis
Technical analysis is a try to make up a trading system, based on indicators, like lines, dots and etc. that display entry points in the chart. It also includes graphic analysis (psychological support and resistance levels, Fibonacci retracement levels), candlestick analysis and patterns (recognized candlestick patterns or formations) and so on. The fans of technical analysis certainly overestimate its efficiency.
1.Force majeure and exception to market wave theory
Indicator is software, written in a programming language (for example, MQL5 language). It is based on a mathematical principle built on different systems statistical data analysis. According to the parameters specified this program analyzes statistics for a specified time period and, based on the pattern, assumes price action.
Note. Remember 2006 and 2010. The statistics was broken by the 2008 mortgage crisis, and a trader who was entering the number of bars for analysis would have seen completely opposite results for 2 years and 5 years. You can believe in the market wave theory like a religion, but there can’t be perfectly still waves! By the way, remembering Brexit and January 15, 2015, when the Swiss National Bank caused turmoil in the market.
No indicator can tell even 99% how the market will behave. Mathematical algorithm can foresee psychology, manipulation and force majeure. Ask the supporters of technical analysis: which oscillator is better and why: stochastic, RSI, MACD? Or something else?
How to avoid the trap:
- The single solution is to understand that there are no perfect indicators. And there no indicators that ideally work in all market situations. You’ll have to test them, analyze fundamental factors, be flexible and look for your own combinations of tools.
To cut it short, you need to develop your own most efficient combination, be mentally flexible, patient and able to manage stress.
2. Crowd instinct and slippages
Imagine that you could still find an ideal combination of technical indicators. You could even order an Expert Advisor. It doesn’t matter what principle it is based on, but you made it available in free access. What do you think will happen if all traders will apply it simultaneously? Or, simply put, if everybody, hypothetically, opens a positions at the same direction simultaneously, following the Expert Advisor signal? Let alone the one, on whose expense all these positions would be provided. The result of missing counterparties to the transaction is slippage.
Admit that the market will just behave in the same way despite the signals of the indicator. That is why the hope that free (as well as paid) strategies will be profitable can help you is false.
How to avoid the trap:
- “Free cheese is only found in the mousetrap”. In most cases, the strategies described on the websites and presented as working ones are not so. The purpose is the same - to attract traffic to the site or convince a person to sign in via an affiliate link. But these strategies won’t do any harm either; they are a perfect simulator to train trading on a demo account. Download indicator templates, install in MT4 and train yourself to adjust indicator setting by testing on the history.
- “Paid cheese in the mousetrap seems to be tastier, but the essence is the same”. But the case is far more interesting. At first sight, paid strategies should be efficient since they aren’t in free access. But just think if it makes any sense to sell an efficient strategy you can make cash on PAMM accounts or social trading . There are numerous examples of fake backtesting, and hardly anybody knows about MyFxBook monitoring.
- There is a single solution: use the basic and combined indicators, train to combine them with each other, develop the trading system yourself and correct it all the time (you will find information with a link on how to adjust trading systems in the final part).
Those, who know how to make more cash on trading and have a winning trading strategy, will hardly share it.
3. Market noise and lagging indicators
Market noise is random sideways price swings in the short-term timeframes. The nature of the noise is difficult to explain: it may be lagging quotes, flaws of the platform itself or the broker’s server equipment, and entering small trades. The price will never draw a chart, looking like a straight line. Unfortunately, market noise affects the indicators getting them send false signals.
Indicator draws in the chart hypothetical price action in future, based on the history of the previous periods. Each last bar can have a strong influence on it, but, by the time the indicator will present the information, including the last bar, there will have been already next bar opened, which, influenced by fundamental factors, may be in the opposite direction. That is a time lag.
How to avoid the trap:
- Operate in timeframes from M30 and longer
- Analyze the price chart with different types of indicators. Don’t focus on the number of trades entered and on the profit. What matters is the accuracy and the minimum risk.
- Avoid history errors, analyze the previous results objectively.
- Analyze indicators and fundamental factors together.
And one more important rule: don’t be too carried away, you shouldn’t change indicators and strategies every day to look for entries. Choose one approach and get it to work!
Conclusion: Neither fundamental, nor technical analysis will guarantee successful trading. And of course, you shouldn’t count on only one type of analysis alone. Successful trading involves the use of these types of analysis in the complex, but even that is sometimes not enough. A trader must also have insight, good reaction, resistance to stress (in order not to lose money at the time of the panic) and remember that institutional capital also controls the market. Yes, it is not easy to make money on speculative price swings, but everything is possible if you make efforts to this and don’t hope for easy money. In conclusion, some useful links:
- Types of forex trading costs and ways to cut them. The article will help you apply all types of analysis more efficiently, and make your trading more cost-effective.
- Rules for evaluating the trading system. The article will of interest to those who like technical analysis and prefers expert advisors, among the other tools.
- The greatest business leaders in the world. The article will motivate you by the life stories of the billionaires who never gave up and manage to earn huge capitals after the age of 40, or the stories of rich people who were born to poor families or didn’t even finish school.
- What shall I do is a broker harmed me? A short guide to what you should do if you suffered a loss because of a broker.
If you have any questions to ask, any ideas to add, or any points to argue – welcome to share them and discuss your ideas in the comments!
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