12 January 2023

Fundamentals Pointing the Way in Forex

One feature of Forex trading is that there can be a detachment between the fundamentals and the way the market reacts. This is because, to some extent, each pair is a relative valuation, thus part of the other pair and its fundamentals are in each move.

News trading attempts to find clarity in valuations in relation to fundamentals. For example it may be assumed that a major news release which can affect USD, will at least affect it for a short while, that is the news trading reaction to data. Afterwards, the complexity of valuation in a Forex pair becomes more of a task in technical trading, which is some sense is made for Forex as from some perspectives it does not unduly concern itself with the world outside of the chart. The assumption is that the interrelationships of fundamentals is in the chart and can be part of the processes which produce tradable charting patterns.

The reality of news trading can be that the complexity does not go away, and the market reacts in ways which do not convey direction, that is the pair can oscillate or not react at all.

Other markets may be driven by fundamentals, as the health of their components can be seen linked to the health of the economy. To some extent Forex is free from this restriction, as it is driven by technical analysis, which by definition does not concern itself with fundamentals, except as they are processed in charting patterns. This makes Forex a 24 hour trading market when it is open, used extensively by both humans and computer programs.

Computer programs can be seen as having this advantage: they can operate around the clock and do not tire. They can also trade at high frequencies, which is a way to try and trade on very small movements in the market. All this of course adds to the complexity of the market.

The trader can follow the crowd and use technical analysis in Forex trading, and indeed sometimes the rationale for using technical analysis is simply that others are doing it. This provides a force to the more popular indicators, such as RSI and MACD, as so many others are using it for signals. So the market can be seen respecting value levels, patterns and other technical signals, at least for a time.

One way into the complexity of Forex is to look for macro patterns which is to say statements about how many times a Forex pair may take to cross a significant figure and what might be expected when it does (based on past action). These patterns can at least point to situations where the market will not continue and may consolidate, or the presence of support or resistance.

Robots do not object to short term trades, but the human trader may find themselves biased towards trades which have a frequency they are comfortable with. Thus they may leave short term trades to robots. So what is a comfortable trade frequency. It comes down to what can be expected from the trade.

Robots do not concern themselves with such factors. They will apply the strategy and can produce negative returns (drawdown), with the strategic aim of becoming positive overall. This is a way to look at trades holistically, rather then sequentially or in parallel (which can be too complex). It is also something the human trader can emulate, but the psychological factors can make this difficult.

All this is the flip side of the always on and tradable nature of Forex, and its different reactions when other markets are not doing much. It can make other markets more compelling (especially in Bull markets), and the understanding of technical factors and patterns may be something that can be useful in other markets. Other markets may be more driven by fundamentals and analysis might take account of this in the way it does not in Forex. Other markets however do not necessarily react as expected to fundamental data either and perhaps Forex can inculcate an appreciation of the wayward nature of all trading.

The technical nature of markets is something which can provide a commonality. The same patterns and reactions can be seen in other markets as in Forex. However there may a different kind of processing of fundamental data which affects technical trading. This can make other markets surprising in their reaction, in a way which Forex may not be. Forex sees similar patterns again and again. However this granularity means that these reactions may not be apparent until after the events, that is they may have gone other ways, and these different paths may have seemed clearer at the time.

A market more driven by fundamentals may provide a way to both obliterate and work with technical patterns. This tendency can be seen as an expression of volatility if there is not a clear fundamental basis for the market. Even if there is, intense volatility can be seen around news in any market, as the valuation landscape is altered. As news releases are the times when fundamentals are traded on, then it can be seen that with Forex, to trade on fundamentals is to trade into volatility, which is why news trades have unexpected results.

However across markets the initial reaction to a news event can be seen potentially as a pointer to later movement. So the news event could be considered in general as a kind of isolated market reaction, but which may lay the seeds for future activity, when the market itself creates conditions for change of its components, if the potential is there (or to accelerate this change).

The more a reaction is unexpected, the more it generally is a surprise, thus the more the reaction, the greater the potential for a more lasting effect, even if the initial move fades. This itself makes for volatility, from the initital reaction, the fading, then the move to and potentially through the market left by the initital news reaction. This is a way in which there is a coherence between fundamentals and reaction, however it is just postponed and extended over time (i.e. it is a complex reaction). This can also be the basis in Forex for extended ranges on the longer term.

Thus fundamentals can point the way in Forex, allied with technical analysis which provides some insight into the structures which enable Forex trends.