Technical Analysis is Based on 3 Factors Common in the Forex Market:
1. Price Moves in Trends
Price movements follow trends. This means that after a trend has been established, the future market movement is more likely to be in the same direction as the Forex trend than to be against it. Most trading strategies are based on this concept.
2. Price Discounts Everything
Technical analysis only considers price movement and assumes that, at any given time, a currency price reflects everything that has or could affect the currency including a country's economy and even the fundamental factors. This only leaves the study of price, which is a product of the supply and demand for a particular currency in the market.
3. History Tends to Repeat Itself
History repeats itself mainly in terms of price movement. The repetitive nature of market movements is attributed to investor psychology; in other words, Foreign exchange participants tend to provide a consistent reaction to the market most of the time. Technical analysis uses chart patterns to analyze these movements. Although these charts represent historical data they are still relevant because they illustrate patterns that often repeat themselves.
Understanding this analysis of the Forex market can be a valuable tool in determining the trend of any market and assisting with entry and exit levels for your trades.
The goal of of these methods is to help traders determine when a market is trending, and when it is not. If the currency pair is moving in one particular direction, then we want to be on board. If it is not, all you are going to do is lose money as you will get whipsawed around and this is not what we want as investors.
Unfortunately, many people fight the trend and buying/selling in the opposite direction of a this direction, trying to pick a top or a bottom, only to see the market move further in the direction of the trend.
Another common mistake traders often make is adding on to a losing position, averaging a loss. This is not a good strategy especially in a strongly trending market. It is something that experienced investors never do. The trend is your friend, never go against it.
This technical studies alert investors of high probability setups and there are no certainties in financial market. Profits come from using proven methods to find a trending currency pair and taking trades in the same direction.
With so many investors using similar tools, technical analysis can become a self fulfilling prophecy. If many investors use the same level as a buying point, the price goes up as everyone will makes similar moves. However, the question is always how long these moves will last?
Understanding this methods will give the currency charts some meaning when you look at them and help you understand why certain movements occurred.
Charts are used with technical indicators to look for patterns that have occurred in the past under certain conditions. When these conditions are noted again, you can use the past studies to make a buy or sell decision with increased probabilities of success because it has happened before.
Some of the most common indicators include:
- Moving Averages
- Relative Strength Index
- Stochastic Oscillator
- Moving Average Convergence Divergence
- Fibonacci Retracement
- Bollinger Bands
Most indicators are shown separately from the chart usually below it. This is because they often use a different scale than that of the chart.
Some of the indicators are shown on the chart itself, such as Moving Averages and Bollinger bands these indicators are referred to as price overlays.
Explanation of these indicators is found under the topic: List of All Forex Indicators
- Relies on Defining Probabilities
- Uses History of Patterns
- Uses Several Analytical Tools (Indicators)
- Uses Chart Patterns
- Uses Many Time-frames
How to Trade With Technical Analysis
Most traders prefer technical analysis over fundamental, because Fundamental is a more difficult strategy to implement as it is required for one to have a lot of knowledge and experience required to successfully analyze the enormous and fundamental data. In addition fundamental is not also very accurate since it involves looking at many factors all at once which might be interpreted differently by other investors.
However, fundamental analysis that involves news trading is unpredictable and it's not so easy to interpret news.
Although technical analysis is also not so easy to master, you may find it not much simpler to master than fundamental, learning the methods used will also take you less time and will be easier to learn due to its nature which involves abiding by the rules.
To learn how to trade currencies successfully, it is important that you understand the 3 strategies, outlined below:
1. Currency pair moves will always follow a trend which can be identified by looking at the chart patterns or the candlestick charts. If any investor tells you that you can also profit from the counter-trends consistently it will not be possible because the trend is the only proven method of making money in Forex.
2. The market forces will drive the currency up or down depending on supply and demand. Factors such as economic news releases might play a role in determining the demand and supply of a currency. Technical analysis seeks to measure the demand and supply of any currency using various tools and indicators. The demand and supply is reflected in the price action. Therefore by simply looking at the price movements themselves and you can predict what direction the price is likely to move towards using one or two indicators - indicators like the moving average or support and resistance levels.
3. The market not only shows the history of the past prices, but will also follow the trend that was in place, until its direction reverses. Some very important indicators used to determine these movements are Moving Averages, MACD, stochastic Oscillator, Bollinger Bands.
When a currency starts to consolidation, which means there is no trend, you should use a different approach to analyze the market. You should use support and resistance levels and breakout trading strategies to analyze the ranging market.
When the market retraces, you should use chart patterns and indicators to analyze whether the current trend will continue or reverse.