The Importance of Fundamentals in Forex Trading
12/05/2013 9:00 am EST
Because of mass psychology, the forex market is relative and not absolute, therefore your trading on any position should be nimble and not absolute, says Tyler Yell of DailyFX.com.
“The greatest obstacle to discovery is not ignorance—it is the illusion of knowledge.”
-Daniel J. Boorstin
Sometimes it is easy to forget that FX is a relative rather than an absolute trade. Therefore, as a consequence, the relative dynamics are just as important (If not more so) as the absolute dynamics. As a trader, your job is to know when the absolutes align with the relative perception because that is when the strong moves take shape.
An Absolute Market Would Have Higher Yielding Currencies Always on Top
Looking above, you’ll see there is a clear variance of countries’ interest rates, which is often a big driver in the FX market. Interest rates are important but the absolute of which country has the highest interest rate won’t do you near as much service as realizing the expectations for future interest rate moves. This brings us into the discussion of an absolute vs. relative market.
The Frustrating Truth of a Non-Absolute FX Market
In an absolute world, crowd psychology is irrelevant. Therefore, there would be no blow-off tops or major crashes because absolutes like earnings, GDP, or interest rates are clear cut. However, even when fundamentals are moving in one direction, price can be moving in another and that is due to the relative nature of markets and the market’s expectations for future growth. This is especially true in foreign exchange.
The Higher Yielding Currency is Losing to the Lower Yielding Currency
As you can imagine, if the markets were absolute and market moves were absent from crowd psychology, then there would be little opportunity to take advantage of a false breakout at great prices or buy off of support when the news is only slightly better than before. However, when a major piece of news prints like GDP, NFP, or a major central bank announcement, and it is in line with what is already priced in or expected, then you’ll likely see little to no move at all, which can be frustrating.
The Forex Market is Relative Due to Mass Psychology
You’re likely asking yourself, if markets aren’t absolute and relative, what does this mean for my trading? Simply put, you need to be nimble like the crowd and while you can spot a trend, you need to know when the market is moving against your bias. Of course, when risk is involved, our behavior changes and that is why the collective market is often weighing the cost of closing out a losing position vs. holding on to see if they can capitalize on their reason for entering the trade.
Focus on Invalidation Points of Your Trade Idea
One sure way to drive yourself frustrated is to try and guess how a mass of irrational people will act out in the market. A far better method, in my opinion, is to find a clean trend and find a fair price to enter in the direction of the trend. Beyond entering in the direction of the trend, you should quickly identify where your trade idea is no longer valid based on price action.
Putting This Information into Action
On a heavy news week like we have to close out this first week of the month, you should have a clear grasp of a handful of things to gauge the relative nature of markets and more importantly price action:
- What are the expectations for the news prints?
- How does price action respond to the news print?
- Where is a safe place for me to enter into the clear trend?
Because the market is not absolute, the expectations of the news prints are only a portion of the equation. Of course, expectations and times of major news prints can be found on the DailyFX Economic Calendar:
DailyFX Economic Calendar
Once the news prints, keep a keen eye on the price action immediately afterward. I often keep an eye for a quick counter trend move that moves to a near level of support or resistance that quickly begins to fade. This tells me that the hot hands that jumped in on the print don’t have enough conviction to hold the move. From there, you can look to enter of a clear resumption of the trend and you can set a stop off the news extreme and look to set a target within the trend.
By Tyler Yell, Trading Instructor, DailyFX.com