Commander in Pips: That, right, son, but first I’ll give you very simple answer, but then explain more. And the answer is as follows – do we really need some other types of analysis, if we have some best of the best? For example, if technical analysis is the best type, why do we still talk about the others?
Pipruit: You do know me pretty well now, Commander. Yeah, that’s right. Besides, this is an obvious question – I have to ask it.
Commander in Pips: No way! I need to get some pleasure to see when you will suffer over it.
Pipruit: Well, Sir, I understand your logic, but only deduction that I can make is that not all things are so obvious, right?
Commander in Pips: Hey, that’s my phrase, do you have a copyright? Ok, you’ve got it right. Now, let’s explain why it works in this way.
First, on your trader’s way, you will meet absolutely different, occasionally fantastic traders, who will try to prove to you, that some way of analysis (likely that they use themselves) is a best. You will meet fans as technical analysis as fundamental, may be even other types of analysis that we do not even know (moon cycles). Don’t be confused by these one-sided enthusiasts. As I already have alluded, no one type of analysis is better than the other. They are just a possibility to look at the market from three different points, and you will get 3D-picture, instead of 2-D, or even 1-D (If it’s possible at all!). Although we’ve already discussed, that as a rule, most traders pick some type of analysis as their primary one, because it gives best results or is most suitable for their particular way of trading and secondary types, that trader uses to interpret current situation on the market. See, we need all types together, and here is how it works:
It’s unwise to negate the fact that eventually currency rates move due to country economic health per se relative to other economies. So, if one economy is healthy and has even stronger perspective and potential, then its currency gains, if not – its currency loses. That is what fundamental analysis stands for. It helps us to make a conclusion about if an economy is healthy at all or not, what perspective does it have, does it grow, flat or recess, is it stronger than another economy, say, EU or not, etc. As a result of the application of fundamental analysis, each trader forms his/her own fundamental outlook as on the current situation as on the future. Let’s go further…
We come to the conclusion that each trader has own fundamental outlook on some country’s economy, say, the US of A. But what does it mean? It means is that each trader has a view how bearish or bullish he/she is on particular economy. The total of these opinions creates a market sentiment. So, fundamental analysis creates shape of assessment by market participants of a US economy, i.e. – total market view (i.e. sentiment) on economy and bullish or bearish sentiment itself.
As technical analysis is dealing with charts – it allows us to see this current market sentiment both in real-time and as historical and to analyze it with technical tools.
Commander in Pips: Yes, in fact, you have all that you need – historical prices, all the necessary figures and data. All you need now is to just study how to apply in-depth analysis as best as you can do and make good trades.
Pipruit: …but could you give me just a common example, how this 3-D way could be applied in real life?
Commander in Pips: Sure. One example you’ve already got – in the first part of current chapter “Different types of market analysis” you’ve seen what a financial catastrophe will be upon you, if you will rely on just technical analysis and totally ignore fundamental and sentiment.
The role of sentiment analysis
Here is another example. Assume that your fundamental analysis shows that economy is growing and on the way to recovery. This assumes that unemployment rate should gradually decrease. Let’s further assume that today is unemployment data release for recent month and you expect unemployment decreasing. You switch on the CNBC channel and a lot of big-headed guys talk about unemployment rate and how important to see it’s decreasing to support the pace of recovery, blah-blah-blah – anyway you’ve got the point - other market participants expect the same, and you just switch the TV off. When the data has been released and unemployment really shows a decrease, you expect to see appreciation of the USD rate and open a trade based on this. Instead of what you expected, you see a strong move against your position. Why, what has happened? Unemployment decreased, the economy grows, what’s wrong, why is everybody selling USD currently? The point is that you totally ignored the sentiment of the market, how bullish or bearish their view on economy. If you have watched CNBC a bit longer that you see that market expectations was for an unemployment reduction of 0.25%, but data that has been released shows a reduction just for 0.1%. It means that the current pace of growth is slower that was expected initially and the USD is overvalued. That’s why it leads to a sell-off of USD on the market. On that simple example you can see, how important Sentiment analysis is.
Combination of different types of analysis
Here I want to show you how you can combine all types. For instance you are the trader who trades long-term trends, and fundamental analysis is a particular important one for you. You do a good job and estimate possible long-term trends changing due to changing situation in fundamentals factors of the US economy, you take into account a public sentiment as well, to fairly judge effect of new released macro data.
Combination of different types of analysis - continued
Say, currently, you see that the economy turns to recovery and shows signs of strength, you see better and better macro data, crowd appetite for positive data (i.e. sentiment) is growing also and you decide to enter on the market based on this – Sell EUR/USD, for instance. But now the question – where to enter, where to place stop/loss order? How can this be done with fundamental analysis? Of cause, you have a possibility just to enter at market without any stops, but in this case you indeed must have ruby wallet to hold any move against you, and this move could be really solid – remember, you trade long-term.
Here is where we come to technical analysis. You can analyze charts and find the area to enter – for example strong resistance level on monthly chart and to place a stop order.
Pipruit: Now it becomes much clearer for me. Thanks. I suppose that I should not rely just on one of them. But here I see another major task – I have to learn to balance them optimally to get best results.
Commander in Pips: You are absolutely right.
Pipruit: And what are we gonna do now?
Commander in Pips: Well, in the nearest time we will dedicate lessons to deeper investigation of technical analysis. First, we will take a look at different chart types, and learn how to read them.
Then, we will turn to the classical approach to technical analysis – classical patterns, trend lines, support, resistance and a lot of different indicators.
After that we will turn to advanced and more sophisticated part of technical analysis – Fibonacci tools, Elliot wave theory, Gartley’s patterns, pivot points and other stuff.
And only after that will shift to fundamental and sentimental analysis.
Pipruit: All right! I can’t wait no longer – let’s get started!