Technical Analysis - General
Technical analysis is a technique used in forecasting the movement of prices and trends of future market. It entails the study of charts of previous market action. Specifically, technical analysis focuses on the past market action instead of future happenings. It also takes into consideration the price of financial instruments and trading volume and then comes up with charts based on that data gathered. With this method, analysts have an edge in tracking many markets and market instruments at the same time.
Generally, there are two types of analysis - the technical and fundamental. Although these two differ in many aspects, they both serve as useful tools to any Forex trader based on similar principles. These principles are on the existence of price patterns and price trends in the market which can be identified and considered as opportunities to earn profit. Either one or both may be used but it"s more common that the successful ones normally use a mix of the two methods for best results.
Three major principles govern technical analysis - markets discount, prices move in trends and history is repetitive.
- Markets discount refers to the actual price being a result of factors known to the market that could cause an effect on it. These factors include supply and demand, political situations and market sentiment. It is, however, important to note that technical analysts are only after price movements rather than the factors that cause such movements.
- Prices are never constant and so, they move in trends. They can move up, down or sideways. A trend is created when any movement takes effect. A market trend, therefore, refers to the direction of prices which is crucial in the technical analysis of currency trading.
- In determining trends, a price chart is normally used. The chart will show a certain trend through a series of waves with highs and lows. An upward trend is described as bullish, a downward trend is considered bearish while a move sideways means that the market is in consolidation.
- History is a cycle and therefore, it repeats itself. This holds true as well in price patterns. Using this concept of history enables a technical analyst in currency trading to forecast the movement of prices. This forecast, in turn, helps traders in deciding what action to take to gain profit.
In the Forex technical analysis theory, price trends are important. When a currency is affected by various factors, it is reflected in the so-called price action as shown in a Forex chart. There are actually five categories involved in a Forex chart -- the indicators, number theory, waves, gaps and trends. Of the five, the indicators are the most commonly used by traders.
Several indicators have proven to be effective in the technical analysis of currency trading. Trend indicators refer to the persistence of price movement for a period of time and are shown in trend lines. Support and resistance indicators show the price levels based on supply and demand. Volatility describes the size of daily fluctuations in price while cycle indicators refer to the repetitive patterns of market movement based on recurring situations. Other general indicators are momentum and sentiment.