Most traders either fall into the technical analysis camp or the fundamental analysis camp when describing their trading strategies. However, both technical and fundamentals play pivotal roles in driving the fx market.
Incorporating both types of analysis into an EA can be difficult due to the different frequencies of data (quarterly/monthly for most fundamental data vs. intraday for technical and pricing data), access to fundamental data (where can I get data from the last ten years?) and difficulty in combining both datasets.
This will give a brief overview for technical traders on the most important fundamental data, where to get data, and, most importantly, how to incorporate it into your strategy. Most of this analysis can be done in TRAIDE, which is currently free to use and is able to generate the EA code.
What is Fundamental Analysis?
Fundamental analysis in the fx market is very similar to equities, namely, traders try asses the real value of a company, except they are evaluating an entire country, or two. They are looking to measure the strength of a countrys economy, reflected by the price of its currency, as compared to other countries.
This is usually referred to as the strength or weakness of a currency. A strong currency is one with a relatively high value while a weak currency has a relatively low value. For example, the AUD/USD has a weaker Australian dollar that only buys around $0.71 of the stronger US Dollar, whereas the GBP/USD has a stronger Great British Pound that buys $1.54 of the weaker US Dollar.
So what determines the strength or weakness of a currency? It is largely driven by a combination of the internal policies of the central banks of each country (see Chinas latest devaluation), the natural market forces of international trade, and institutional order flow (the importance of each factor is a matter of some very passionate debates and usually determined by your own personal view of the world).
What Fundamental Data Should I Use and Where Can I Get It?
The fundamental data you choose to incorporate is going to be dependent on the currencies you trade as well as the factors you believe are important. There are a few that are generally seen as more important. (Quandl is a great source for free, easily accessible financial data.)
Interest Rates
- With the next FOMC (Federal Open Market Committee) meeting on December 16th, there is sure to be a lot of talk about raising interest rates. This interest rate usually refers to the Federal Funds Rate, or the rate at which larger member banks can borrow from the Federal Reserve. It is an important metric of both internal economic growth as well as factoring directly into the fx market by traders looking to earn interest by buying currencies with higher interest rates, known as a Carry Trade.
- You can download the daily Federal Funds Rate from Quandl here.
Non-Farm Payroll
- You will hear the Non-Farm payroll (NFP) brought up frequently, especially around its quarterly release. The NFP represents the total number of paid workers excluding government employees, non-profit and private household employees, as well as farm employees. This is seen as a good indication of a countrys health as it affects all markets (farms are excluded as seasonality distorts hiring numbers).
- You can download the US NFP from Quandl here.
Commodity Prices
- For countries with large internal industries driven by relatively few commodities, the price of the commodity can be an important drive of their economic growth and the relative value of their currency. The economies of countries like Australia, Canada, and New Zealand, for example, are strongly related to the price of oil.
- You can download crude oil price from Quandl here.
How Can I Incorporate This In My Strategy?
Now that you have all this data, how do you actually use it? Most of this data in daily, monthly, or evenly quarterly, where your strategy could be on 4-hour charts, and you have no easy way to code this into an automated strategy.
Luckily, there are a couple techniques that can be used to relatively easily incorporate fundamental data into your technical strategy.
Implementing a Bias
- Lets assume you have an intraday technical based strategy that youve developed but you frequently find yourself trading against broader macro trends. One relatively simple solution would be to including a bias into your strategy. A bias can be thought of as externally nudging your strategy toward the direction that the fundamentals suggest. For example, if the upcoming FOMC meeting in December does lead the Fed to increase interest rates it would suggest the dollar should appreciate against weaker currencies. While you dont want to commit to month long trades, with serious drawdowns, you shouldnt ignore news of this magnitude. You can then add a bias in your strategy that promotes trades in the direction of the fundamental indicators. This could be done in the form of different position sizes depending on the direction of the trade, e.g. 2 lots for long and 1 lot for short, changing the risk-to-reward ratio when buying and selling to give trades in the desired direction more freedom to run, or even relaxing the entry conditions to enter in more trades in the desired direction.
- This is a straightforward technique that can be relatively easily tested and implemented with any technical strategy.
Building a Fully Fundamental Strategy
- Fundamental strategies, like the Carry Trade mentioned earlier, are not for everyone; they require long holding periods (usually a couple months), are prone to large drawdowns, and require a fairly in-depth understanding of macroeconomics. However, they can be a great way to diversify your strategies and times of economic uncertainty can lead to great opportunities To create a fundamental strategy, focus on one specific pair, analyze the economic conditions of each country, make sure you are trading in line with both central banks goals (it doesnt hurt if you can see a strong technical trend also forming on weekly or monthly charts), enter a trade and leave it alone! You should be looking for 500+ pips for these types of trades with a wide emergency stop in place.
Combining Technical and Fundamental Entry Signals
- If you trade on longer timeframes (4 hours and above), it is possible to combine technical and fundamental data into a single strategy. You usually want to look for changes in the fundamental data, e.g. oil prices increased 2%, instead of just the price.These strategies should be thoroughly tested, and you may need to enter into the trades manually, but it can lead to very robust strategies.
- Note: this is not the same as trading the news release! Attempting to trade the release of the news is difficult for at least one major reason: it is almost impossible to backtest. Historical data will not accurately reflect the spread, fill price, how fast the market is moving, and, on top of that, even the same release in consecutive months can have vastly different characteristics based on a huge variety of factors. If your strategy trades on longer timeframes, waiting a few minutes after the release will not have a major impact on your overall returns and is preferable to the large random swings that accompany major news announcements (you can find a list of all major announcements here).
Not including both technical and fundamental data into your strategy is limiting yourself to just one perspective of the market. You should be using all the relevant information you can get your hands on to give yourself an edge.
With TRAIDE, we have just released a wide range of fundamental data that you can easily analyze with machine-learning algorithms. Get started for free here.