Technical, fundamental or sentiment: which should you use?

Two traders can watch the same rise in EUR/USD and explain it differently. One points to a change in what markets expect from interest rates. The other points to a break above a price that had capped the pair twice.

Both explanations can be true at once. They describe different parts of the same move, which is why the three schools in the three ways to analyse the forex market are easier to use together than to rank.

Is one type of analysis better than the others?

None of them has strong evidence of beating the market on its own.

Since the early 1980s, economists have found that models built on economic data struggle to forecast exchange rates better than a simple guess of no change, at horizons up to about a year.

Studies of simple chart rules in currencies show mixed results. Some rules that looked profitable in older data did worse in later years, and trading costs shrink what is left.

Sentiment has its own gap. A crowded position can stay crowded for weeks before it turns, and positioning data does not tell you when the turn will come.

Each approach is better suited to a different job, so a more useful question is which job you are doing right now.

What question does each approach answer?

Fundamental analysis looks at the economy behind a currency: interest rates, inflation, growth and central bank policy. Its output is a bias, a view of which way a pair should drift over weeks or months.

Sentiment analysis measures how other traders are positioned and how much risk they want to take. It tells you whether a view is already shared by so many people that few new buyers or sellers are left.

Technical analysis studies the price chart itself. It supplies the levels: where to enter, where your idea is proven wrong, and where to take profit.

One way to use them is in that order, from slow to fast. The fundamental view picks a direction, the sentiment check can veto it, and the chart decides the exact prices.

How do the three fit together on one trade?

Here is the process on one EUR/USD trade. Every number is illustrative and chosen to make the arithmetic easy, so treat the trade as a demonstration of the method and nothing more.

1. Start with the fundamental bias. Suppose the European Central Bank is expected to hold rates while the US Federal Reserve is expected to cut. A rate gap moving in the euro's favour tends to support EUR/USD, unless markets have already priced it in, so your bias is to look for buys.
2. Check sentiment next. Suppose the latest Commitments of Traders report shows speculators only moderately long the euro, well short of past extremes. The trade does not look crowded, so sentiment raises no warning.
3. Look at the economic calendar. Suppose no major release for either currency is due in the next day, so a scheduled number is unlikely to jump the price while you enter.
4. Use the chart for timing. Price has fallen into a support zone around 1.08000 and bounced. You buy at 1.08200, place the stop at 1.07900 below the zone, and set a target at 1.08800.
5. Measure the distances. The stop is 1.08200 minus 1.07900 = 0.00300, or 30 pips. The target is 1.08800 minus 1.08200 = 0.00600, or 60 pips, twice the risk.

Now size the trade. With a $5,000 account and a plan to risk 1% per trade, the most you can lose is $50. Divide by the 30 pip stop: $50 ÷ 30 = $1.67 per pip.

On EUR/USD one standard lot is worth $10 a pip, so $1.67 a pip needs about 0.167 lot. Round down to 0.16 lot, where a pip is worth $1.60.

The stop now costs 30 × $1.60 = $48, and the target pays 60 × $1.60 = $96. The position size lesson repeats this step for other pairs.

These sums leave out the spread and any commission, which make the real loss slightly larger and the real gain slightly smaller.

Each layer had a job, and none of them predicted the result. If the price falls to 1.07900, you lose $48 however sound the fundamental case looked.

How do you combine indicators without crowding the chart?

Every indicator is calculated from the same prices. RSI, the stochastic oscillator and CCI (the Commodity Channel Index) all measure momentum, so they tend to rise and fall together.

Put all three on a chart and they will often agree. That agreement is one reading shown three times, and it can make a weak signal look stronger than it is.

A leaner chart uses one tool per question: one for trend, such as a 50 period exponential moving average (EMA), one for momentum, such as RSI, and the price levels you drew yourself. The lesson on combining indicators goes further.

Fundamentals and sentiment need no space on the chart at all. A one line note above your levels carries them, for example "bias long, positioning neutral, no news today".

How should your trading style change the mix?

The time you hold a trade decides how much each approach can help. A scalper holding for minutes leans almost entirely on the chart, because a rate decision expected next month barely matters in that window.

Even a scalper needs the calendar. A surprise in a major release can move a pair tens of pips in seconds, enough to jump past a tight stop.

A swing trader holding for days to weeks has the most reason to use all three. Those trades last long enough for economic news and shifts in positioning to move the price.

A position trader holding for months usually puts the most weight on fundamentals. The chart still matters, because a sound view entered at a poor price can sit in a loss for a long time.

What if the approaches disagree?

Sometimes the fundamental bias says up while the chart keeps making lower lows. Neither view is wrong by definition: the economy may be shifting slowly while short term traders keep selling.

You can stand aside until the two line up, trade a smaller size, or follow one view and accept the risk the other points to.

One rule you could write into a plan is to take chart signals only when they agree with your bias.

It cuts the number of trades and carries no guarantee of better results, so test it on past data and a demo account before you rely on it.