How to Use Fundamental Analysis to Prepare Trades
How to Use Fundamental Analysis to Prepare Trades
Using fundamental analysis alongside technical analysis can be a powerful way to trade the markets. It is important to understand that fundamental analysis helps you to understand what is moving the markets while technical analysis can help you in timing your trades and picking the right price levels to enter trades.
This brings us to the question as to how to prepare your trades using fundamental analysis and how it can be combined with your technical trading, which is what you will learn in this article.
Fundamental Analysis Starts with the Economic Calendar
The first step in fundamental analysis is to get an overview of the upcoming economic events. It is always best to start your fundamental analysis at the beginning of the week, looking at all of the events scheduled for the upcoming five day trading period. This ensures that you can then focus on the specific currencies where there are significant events scheduled.
Starting with the weekly forex economic calendar, the first step is to filter out the low impact events. On the economic calendar, most of the events are categorized into High, Medium and Low-impact events. However, in some cases even the low impact events can move the markets significantly. Therefore, always survey all of the weekly events that are scheduled and then filter out the less important ones.
Now that you have narrowed down the list to the main events that will shape the markets, the next step is to further narrow down the list to focus on specific currency pairs that you are interested in trading.
For example, if EURUSD is your focus for the week ahead, then filter the economic calendar based on high or medium impact events relating to the Eurozone and the US.
The resulting list of economic events will now give you a broad picture of what to anticipate during the week.
- Always plan your trades over the weekend by starting with the weekly economic calendar
- Filter out the events based on their expected market impact and then focus on the currency pairs that you want to trade
- Ensure that there are no outlier events that could impact the currencies in question
- Make a note of the exact timing of the releases
Making Use of Charts to Augment the Fundamentals
The next step is to take a look at the charts, preferably start your fundamental analysis from a weekly time frame and scale down to the preferred shorter time frame of your choice.
Usually, the weekly and daily time frames give you a broad picture of price trends as well as any potential reversals that could be on the horizon (candlestick patterns or confluence with indicators).
Based on your approach to technical analysis (be it using indicators or just price action), the next step is to chart the potential support and resistance levels where prices will likely pullback from a trend.
What are the Market’s Expectations?
The next step, which is the final stage, is to understand what the market’s expectations are. Do not confuse this step with the forecasted or expected data points themselves.
Besides the analysts’ forecasted numbers, the markets tend to price in their own forecasts, or broadly put how the economic release will affect the asset prices. The best way to gather this information is to read through the related articles on financial websites such as CNBC, Bloomberg or Reuters Finance.
Generally, the more significant an event is expected to be, the earlier financial markets begin to talk about it. Gathering this information is critical as it shows how the markets are positioned into the event.
For example, if US GDP is forecasted to rise 0.90% in a quarter and the markets are expecting to see an increase or a beat on the estimates, it is quite clear that the markets have already priced in a bullish event. This means that in case the actual figure falls below the forecasts, the downside risks are greater.
Now, when you combine this information with the technical levels on your chart, it gets a lot easier to trade at the right levels and in the direction of the trend.
Fundamental Analysis: A Practical Example
Now that you have all the information needed, the next step is to wait for the event to occur. Rather than blindly buying or selling on the outcome of the event, it is best to wait a while before you decide what to do.
If you notice that prices have fallen to a support level and the trend is up, long positions are favorable and vice versa at the resistance levels.
Always check before entering a trade that the currency in question does not have additional events coming up with a short span of time as this could result in the asset moving sideways.
Example – EURUSD trading based on fundamental and technical analysis
The above image shows the list of economic events that relate to the Euro and the US Dollar during the week of February 15 through 19th.
Notice that between Monday and Friday, there are a lot of events scheduled. From the above list, we can further filter the calendar to show only the more significant events that will shape the currency pair.
The filtered calendar now shows a speech by the ECB President Mario Draghi followed by a report on the US Producer Prices Index, the US FOMC meeting minutes and US inflation data.
The following chart below shows how the above helped set up a trade in EURUSD based on the support and resistance levels from technical analysis and using the fundamental analysis to trade accordingly.
After the support and resistance levels were plotted, EURUSD was trading lower following dovish comments from ECB president Mario Draghi.
Then, US PPI beat estimates, rising 0.10%, which saw the Euro weaken further relative to the Dollar. The FOMC meeting minutes saw a small bullish close but by that time, EURUSD was already trading below the next support level at 1.1107.
By the time the US CPI data came out late on Friday, EURUSD broke the support level, saw a bit of consolidation and continued to decline, falling to the next lower support near 1.0949 – 1.0932.
The above example shows how fundamental analysis can help you not only understand what is moving the markets, but it also adds confidence to your technical trading, something which is lost when used in isolation.