Combining Fundamentals with Technical Analysis

At some point, every trader finds themselves asking the inevitable question: To whether to rely on fundamentals or technicals? Some traders will spend hours tracking charts while others will find themselves poring over data or news about the economy.

The truth is, if you subscribe to just one way of looking at the outcome, you are missing some element of trading on either side of the debate. What the best traders, and indeed the most consistent traders, find is that combining fundamental analysis with technical analysis will produce the clearest picture of the market.

Consider the analogy in driving a car; the fundamentals are the engine that launches the car forward, and the technical analysis is the steering wheel that tells you where to go, when to stop, and which position to turn. If you want to get to your destination in one piece and as efficiently as possible, you need both.

What Is Fundamental Analysis?

Fundamental analysis seeks to examine the underlying factors driving a market's price action to understand why it moves in a particular way. It aims to analyze the foundational/intrinsic components of supply and demand, whether from a company's perspective, country-level, or the entire global economy.

The fundamental components to analyze vary with the market being traded, but the following apply to many developed and developing countries:

• Economic Indicators: Such economic data as gross domestic product (GDP) growth, employment or unemployment, retail sales, and inflation are all critical measures that help explain whether the economy is strong or weak.

• Central Bank Equipment: Central bank monetary policy evaluations, interest rate decisions, any stimulus or tightening of policy have a direct link to the currency and bond markets moving preciously to medium and long-term.

• What's Happening: For equities, earnings information, potential earnings growth, or discussion of cash flow and debt all help depict whether a stock is likely undervalued or overvalued.

• Global Events: The impact of elections, wars, trade agreements, and crises has all proven to move markets more with some events than others.

Fundamental analysis can help define the long-term trends. To consider an example, consider a strong and stable economy; this typically supports a currency's strength over time. While the fundamentals address the "why" behind a financial market movement, technical analysis examines the "when" more closely. This discipline addresses current behavior in price and volume to predict a future move. Some tools and techniques traders use for technical analysis include:

• Candlestick Patterns: Reversal signatures such as a hammer, engulfing, or shooting star.

• Support and Resistance: Price clusters where supply or demand will typically show up.

• Indicators: Relative Strength Indicator (RSI), Moving Average Convergence Divergence (MACD), Bollinger Bands, and moving averages are used to assess momentum, volatility, and trend direction.

• Chart Formations: Triangles, flags, and head-and-shoulders formations often signify continuation or reversal setups.

Technical analysis is most helpful in timing short-term movements- determining where to enter and exit a market for the larger context.

Why Use Both Analyses Together?

There are issues with using a single approach:

• Fundamentals may provide a general directional view, but do not lead to a good entry.

• Technicals may help with timing- but you could have unexpected fundamentals that pose risk.

When used together, you:

• Direction derived from fundamentals.

• Timing derived from technicals.

Using both means less uncertainty and a greater probability of trades.

Real World Examples

Example One: Forex Trading.

Let's say the European Central Bank suggests it may cut rates to mitigate inflation. The fundamentals suggest the euro may weaken. A trader could decide not to short EUR/USD right away. Instead, the trader can wait for the technicals to confirm that the price has broken support before taking action.

Example Two: Stocks

A technology company announces its quarterly earnings, stating that revenues and earnings exceeded market expectations. A trader acknowledged the strong fundamentals. Although the fundamentals indicate advancements, the trader would wait for the stock to break out of an accumulation or consolidation on the chart before buying.

Example 3: Commodity Price Action

Oil prices are rising due to concerns over supply. A fundamental view would be in favor of bullishness, but the technicals can provide the best entry zone after a correction or pullback.

How to Combine Them Step by Step

1. Start with the fundamentals

Take a step back and look at the broader view. Which currency, stock, or commodity has fundamentals supporting a strong view? Which one is weak?

2. Add on technicals

Use charts to determine the best time to buy or sell. Look for signals, such as a breakout, testing a trendline, or confirmation on an indicator.

3. Take in the sentiment of the market

In any situation, traders may overreact or underreact to news. Using technicals in conjunction with sentiment will show you a better feel of the short-term mood.

4. Putting together your risk

Both forms of analysis should feed into your risk management — when placing stops, how much to risk, and when to close out a trade for a profit.

Benefits of the two combined

• You have more confidence. You are not only relying on one source of information.

• Better timing: While fundamentals set the stage, technicals tell you at what point the play is about to begin.

• Fewer false signals: If both signal analyses align with one another, it gives you a stronger signal to initiate a trade.

• More versatility: Applies to different markets, as well as timeframes for all forms of analysis.

Some Common Errors

• Overlooking context: Some traders utilize technicals without questioning if the fundamentals are supportive of that movement.

• Over-analyzing: Using too many indicators or trying to match every piece of data can generate confusion.

• Blindly trading news spikes: Large releases almost always induce whipsaws; it's wise to step back and wait for confirmation from the technicals.

• To have a bias and overconfidence: Traders sometimes interpret the fundamentals to suit their existing trade idea.

The Trader Plays

1. Follow the Economic Calendar. Always know when a major release is coming, such as CPI, GDP, and interest rates.

2. Think in multi-timeframes, fundamentals suggest a long-term directional movement, technical in the short to medium term.

3. Write down your logic. Journaling trades, which incorporate both, assist in developing your system.

4. Have discipline, do not abandon either if you are not taking biased trades.

An example in multiple timeframes

Let's say you are a swing trader who monitors GBP/USD:

- Monthly chart: long-term uptrend.

- Weekly chart: It is in a consolidation phase.

- Daily chart: broken out on the upside, this aligns fundamentally with a strong U.K. GDP growth (+ #).

When the two analyses align with timeframes, you increase the probability of taking advantage of the larger move and not being shaken out on smaller, transient price movements.

Conclusion

The fundamentalists and technicians will likely agree to disagree. Still, both offer valuable perspectives on the fact that price action is influenced by deep economic performance, while at the same time, it is also swayed by price action. The most accomplished traders are not necessarily traditionalists; they are pragmatists and take the best of both.

Fundamentals offer you a why: the story of the asset and direction. Technicals offer you the when: the best entry and exit.

Using both, you'll be in a better position for timing, asset management, and confidence. No tool is perfect in itself in trading; however, the combination of fundamentals and technicals offers the best opportunity for a probabilistic outcome that is more powerful than either individually.