Forex trading is an immensely profitable venture but may I add very risky as well. We have traders making 5 figures or more constantly on a monthly basis. Many have been in the business for years or are in a good network that provide them very profitable tips and at the right time.
Some traders swear by the fundamental method while others prefer the technical method. While some who are the hybrid types, use the two. Which of these are right?
Many say the money is in the trends. So they like the candle sticks, moving averages, MACD, charts etc. And many have made big bucks doing so. Yes, it is true that the market does mirror some trends. The question is what happens when things go wrong or may I add, spectacularly wrong i.e. when the markets move unexpectedly due to a major world event, one unforeseen by the model?
Crisis could occur unexpectedly as was frequent in the 1990’s such as the Mexican devaluation of 1994, the Asian crisis (1997) and the Russian default (1998). These unexpected events usually make models irrelevant and often lead to excessively high losses.
A case in point is Long Term Capital Management founded by John Merwether? It was a hedge fund that went belly up in 1998. Its specialty was bonds but the model used was akin to that of the technical analytical model used in forex trading. This eventually proved to be its undoing.
Founded in 1994, and making use of computer models, it made high returns, over 30% annually for the first few years. Things however took a turn for the worse in 1998 when it lost $4.6billion in a space of only 4months. The U.S government had to come to its rescue. And interesting its trading formula was one of the most advanced in its field having been designed by two Nobel laureates. It was the unexpected Russian default of 1998 that finally sealed its fate. From this, it never recovered
Many newbies in the forex business may start off making profits using the technical analytical model but many eventually make losses just like LTCM. It is said that 90% of traders make losses and I am sure that majority of these are the inexperienced using technical model.
Do not get me wrong. Traders do make money based on the technical model but an overemphasis on it can be dangerous-very dangerous. Flexibility is the key.
What about fundamental analysis? Though not fool proof, it has proven more resilient and long lasting. Traders who use this model tend to be professional and therefore quite skilled.
One of the greatest kills made in the forex industry was when George Soros a formidable trader bet that the British Pound would be forced to devalue in 1992. He did bet heavily on this and was reputed to have made a $1billion in that trade.
How did he put fundamental analysis to work? He knew then that the strong pound was adversely affecting the British economy and the only way out was for the currency to weaken and that sooner or later, the government would capitulate. And that was what happened.
He was heavily involved in betting against Asian currencies in 1997 and it was his activities and those of other traders that eventually brought the then known rising tigers- Thailand, Malaysia and Indonesia to their knees.
Their currencies then were not only strong or to use the proper word-overvalued but their current account deficits were over the top, as high as 8% instead of the more prudent 3% or less. And to add to their woes, their companies had borrowed heavily from foreign banks. It was a ticking time bomb which he only capitalized on.
All traders desire to have such mega-kills as Mr Soros had. He is a legend. That is the result of knowing your onions.
Technical analysis good but fundamental-much, much better.
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