Basic economics informs us that prices are determined by supply and demand; if the market goes up, one can conclude that there are more buyers than sellers and visa versa. Similarly, fundamental trading will determine a trade's direction based on what the data reveals. Usually, good or positive data supports a market rally but if a trader or institution close a relatively large position and take profits, the prices will fall, often to the bewilderment and consternation of the fundamentalist.
A trader should know whether an economy is doing well and let that information determine the directional bias for his trades. However, it is best to have the charts and technical analysis confirm any trade entry. No doubt there are successful fundamental traders but here are some inherent problems of this strategy:
- While the trader is busy trying to make sense of the news release, the market might be moving too quickly for a profit to be made from the move, once he is finished analyzing and ready to trade.
- The market might have already priced in the news that was just released. So the current release will have little effect on the market.
- Some insiders might have already gotten the information/data before the specified release time. Though some media houses are privy to pre-releases and are under embargo not to release it to the market until the scheduled time, it is naive to think that no trader has access to and will trade the pre-release.
- The news or data that was released might be wrong. If this happens the market might do a whipsaw correction, contrary to what the release suggests should happen.
- The conclusions drawn from analyzing the release might be incorrect.
In March of 2009, Switzerland's central bank announced that it would take decisive actions to stem the unabated appreciation of its currency against the EUR, by selling the Swiss Franc; at least that's what it said they would do. Even though the EUR/CHF rallied on the news, the pair didn't make new highs and slowly drifted down. This left many fundamental traders, who entered long positions, stuck with bad trades. Had they done a cursory analysis of the charts, they would have seen that the pair had rallied too hard and was set for a reversal.
Even though a central bank has the power to move its currency, it is market forces that actually make things happen and therefore any rhetoric coming from them must be considered with apprehension.
Though the charts can give important clues as to
where significant demand and supply levels are, no one can be absolutely sure
what's going to happen in the next instance.
The best a forex trader can do is to know when the news will be
released, but let the charts and technical analysis show where prices are
likely to go.