We will be looking at a 3 step guide to help you actually find a trade, once you have identified an opportunity based on that long term fundamental outlook.
We will also be introducing you to an extremely important concept, called sentiment. This is going to be vital to your understanding of how and why currencies move on a very short term basis.
If you want to be a day trader and you do not know about sentiment, then you are doomed to fail from the very start.
So let’s begin with the three step check list that you need to complete when looking for trading opportunities based on standard fundamental analysis.
Trading with the longer term fundamentals is perfect if you have a full time job or if your schedule only allows you to engage with the markets on a part time basis.
The first step we are going to look at when trying to find a longer term opportunity is that of finding the cause of the most recent price move.
This will tell you a lot about whether or not there is an opportunity at all.
For example, if your fundamental analysis is telling you to look for buying opportunities on the GBP/USD currency pair, then you need to take a look at that pair and see which way the price has been moving.
If the price has been falling or moving in the opposite direction to the long term fundamental outlook then this could potentially be a great opportunity to start buying it back at a much cheaper price, which in turn, will give you a very reasonable expectation for making money as it starts moving in line with the overall fundamental picture once again.
You need to be cautious however, because there is a chance that something may have happened that was previously unexpected by the market that could suddenly change that overall fundamental picture.
This of course could lead to you losing money as the price keeps on moving against the anticipated direction.
This is why understanding the reasons behind the most recent move is so crucial.
You are trying to assess whether or not the market is simply trading in a way that gives you a better price or telling you about a shift in the fundamental picture.
The second step is to fully understand exactly what the big picture fundamental out-look actually is. The best question to ask at this stage is ‘What is the central bank most likely to do next with their monetary policy’ … And ‘is that likely to be positive or negative for the currency?’
The answer to this question is heavily related to the answer to the question we asked in step one.
This is because, if the reasons the price has been moving recently do not change that big picture fundamental outlook then we have a clear opportunity to buy or sell this currency pair back at a nice better price.
Getting to grips with this concept of changing outlook is one of the most important elements of trading the fundamentals.
Once you master this you will have a very solid way of valuing currencies and identifying profitable trading opportunities.
There is of course a third and final step to finding a great trade opportunity when using fundamental analysis. And this step is all about finding a good entry point.
Getting into the market is important because it will determine how much you risk and also how much profit you will make.
Enter the market at a bad price and you will have a higher chance of getting stopped out and have a lower profit potential.
If you can secure a good price then your stop can be much smaller while allowing you a much greater potential for making a profit.
So what is the key to finding a good entry into the market?
The answer lies in letting the market show you where it believes the best entry prices are, and this is where the concept of technical analysis can be so useful.
Imagine if you had a special book. And in that book it contained all of the prices and you could see at which prices the market had been buying or selling.
Crucially, imagine being able to see how much buying or selling had taken place at each price.
This information would allow you to get a very solid idea of where the markets might have their next set of buying or selling orders ready and waiting.
If they are all buying from a specific level at a specific time then this is where we also want to be entering the market, so that we can ride the wave that follows, and make money.
Technical analysis is a very popular concept and has merit, but it is something that most retail traders over rely on when trying to make money.
The traditional issue that most technical traders face is simply not knowing which of their signals to follow. Do you only take the buying signals or the selling signals or do you just take them all?
Ofcourse, if you have been trading solely based on technical analysis then you will know of the frustrations this can cause.
Some days you will miss the best moves and other days you will get cut to pieces as the market just ranges without really moving anywhere.
But imagine if you knew the overall direction, thanks to your fundamental analysis, and your job was to simply take the signals in line with that direction.
Suddenly, you’re able to identify days when there could be a lot of volatility and also those days where the price will most likely just stay range bound.
This allows you to focus much more on taking only the highest probability signals at the correct time.
You may have noticed that it really doesn’t matter which technical strategy you use for this process. The key point is that you are adding in fundamental analysis to improve your overall results.
If you do have a technical strategy that you enjoy working with then that is great and you should stick with that as you start to implement fundamental analysis alongside it.
If you do not have a particular technical strategy that you use then we will provide you with one that is commonly used by professional traders inside firms and banks.
The process is remarkably simple and brings us back to the illustration of that special book that tells us where the market has previously been buying or selling from.
In reality, we do not need a book, because a simple price chart can give us that same information.
When looking at a common candlestick based price chart you will be aware of certain areas that the price reacted from.
This is essentially showing us the exact price levels that the market has singled out as good places to trade from.
It makes sense that if the overall direction is still the same and the fundamental outlook has not changed that these prices will remain attractive to the majority of large market players.
When these price levels are hit again, it makes perfect sense that they will once again look to enter the market, just as they had recently done.
This concept is known as support and resistance and can be used for buying and selling in equal measure.
The key to using these levels is in your overall analysis of the bigger fundamental picture.
As long as this has not changed then these levels are golden opportunities to trade with the rest of the market and ride the waves caused by all of this activity.
This might sound remarkably simple and it is… But only once you have grasped the concept of correctly understanding the fundamentals.
Trying to trade these levels randomly or in the direction of trends derived from purely technical sources will inevitably lead to the same frustrations that you may have already experienced.
This frustration leads to a lack of confidence in your trading which in turn leads you right back to that deadly cycle of switching strategies and losing money.
This combination of understanding the markets and knowing which way the currency should be moving and then searching for an entry based on where the markets have already shown their interest will almost immediately improve your results.
Go away and test this out over the next few weeks, and see for yourself.
As mentioned you do not have to trade from support and resistance and can instead use the many myriad of technical strategies that have been invented by the retail trading education industry.
But always remember that the ratio of analysis that you use should remain 80% fundamental and 20% technical in order for you to see continued, sustained profitability over your trading career.
This combination applies to longer term trading strategies but also to shorter term trading too.
As we discussed at the start of this video we are going to introduce you to a concept called sentiment.
Sentiment is something many retail traders overlook or are not even aware of at all, but it is essential to anyone that wants to understand how the markets move on a daily basis throughout each of the major sessions.
One of the questions we get asked on a regular basis is how do professional traders know which currencies to trade and which way to trade them as they sit down at their desks each morning.
The answer is sentiment.
Sentiment is one level up from fundamental analysis.
Whereas the fundamentals focus on the facts surrounding which way currencies should be moving, the sentiment focuses on which way they actually are moving and the reasons why.
Sentiment simply means the mood of the market.
So just like people have different moods and emotions, so does the market, because after all, the market is just a large group of people all engaging with one another electronically.
A classic example of this changing moods is in something called ‘safe haven plays’.
A safe haven play is where the markets buy a currency that is viewed as strong and stable, during times when the overall economy is viewed as weak and unstable. Traders and investors want security for their money.
Certain currencies are traditionally known as safe haven currencies. For example, USD, CFH and JPY are generally regarded as the safe currencies where investors flock to shelter from short term economic storms.
Very often we see situations arise where the fundamental picture for a currency is very much negative and we can reasonably expect that currency to weaken.
In a hypothetical example we can take one of the safe haven currencies such as USD and imagine that the long-term fundamental outlook suggests that the currency will most likely be sold off and decrease in value.
This means that we could be looking for scenarios where the currency is rallying or increasing in value so that we can then sell it again at a better price.
This would work well in normal circumstances when the markets are trading basic fundamentals.
If however there were a sudden, unexpected event that caused the market to panic, things would change, both quickly and drastically.
For example, if a major conflict broke out between two large nations or if there was a serious market crash, the markets may panic and flock to their traditional safe havens.
In our hypothetical example, you may be selling USD as this starts to play out.
BUT because the market is in a negative mood that is solely focused on protecting their capital, they will probably ignore the long-term fundamentals of the currency in exchange for the safety and security that it offers in the short term.
This will cause the price of the currency to rapidly increase in value for as long as the market genuinely believes it is at risk.
If you are oblivious to the concept of the market experiencing large shifts in mood or sentiment then you are at risk of losing money when it happens.
In our example, the USD would continue getting stronger and stronger while you continue to look to sell it. This can become dangerous, confusing and damaging to your account.
As a longer term trader you should be aware of the concept of sentiment and also tuned into what mood the markets are currently in.
This will allow you to assess the severity of the situation and whether or not what you are seeing really is a great opportunity or something you simply want to sit out of until the markets re-focus back onto the fundamentals.
If you are a short term day trader then these mood swings will become your bread and butter.
The longer-term fundamentals become less relevant because you can make profits riding these moves as they happen, even if they temporarily go against the overall picture.
The key, of course, comes back to having that understanding of the markets and then knowing how to trade that and take advantage of those opportunities.
Whether or not you are a part time trader or a day trader, an understanding of both the longer term fundamental picture and the current, short term, sentiment of the market is going to be pivotal to your success.
Now that you have the framework for understanding the market and finding trades, you’ll find it so much easier to find high probability trading opportunities.