This trading discipline is one of the most popular and efficient techniques used by analysts and investors in the forex market to determine future prices and find trading opportunities. While fundamental analysis helps a trader to evaluate the intrinsic value of an asset in financial markets, technical analysis focuses on predicting future price movements by using repetitive patterns and statistical algorithms.
So in this lesson, we’ll briefly explore the basics of technical analysis and the most important aspects you need to know to start using this trading strategy.
In forex trading, technical analysis is a forex market evaluation methodology that helps traders to predict the next direction of currency pairs’ prices based on historical price movements and chart patterns. According to technical traders, markets always move in repetitive patterns that can be seen and identified in trading charts. It has four primary principles categorized into four components that are utilized on financial charts: patterns, indicators, trends, and entry and exit level signals.
Generally, technical analysis can be used on any traded financial instrument and all asset classes, however, it is especially seen as an effective trading strategy when trading forex due to the structure and high liquidity of the Forex market. Further, it is mostly used by traders with short-term investment objectives rather than long-term investors.
Technical analysis relies mostly on the following principles.
More than anything else, the idea of technical analysis is that history repeats itself. With this notion, traders are essentially looking for the past performance of an asset and by using this data, they can potentially predict the next direction. For example, if the EUR/USD reaches a certain resistance level and breaks above this level, a technical analyst trader will, therefore, use this data to take a long buying position.
Another key principle is that all the data and price action – including market news, price expectations, forecasts, data, interest rates – all are priced into the volume and assets’ price that is shown in the charts. In other words, they believe that fundamental analysis is less necessary than technical analysis as all the data is simply priced into the chart.
The final technical analysis assumption is that prices always move in trends. This means that once the current trend has started, the next price direction is more likely to continue in the same initial trend direction rather than move against it. Crucially, the vast majority of technical analysis trading strategies and indicators are based on this assumption.
Well, basically yes it works. I mean, many traders who have had successful trading experience in the forex markets used technical analysis as their primary trading strategy. But obviously, that’s subjective to every trader’s personality and type of trading.
One thing to keep in mind is that technical analysis is not a crystal ball. It’s best when combined with fundamental analysis and establishing the skill of getting a sense of market sentiment. Nonetheless, there’s no doubt that technical analysis helps many forex traders to identify entry and exit levels, know when the market is in an overbought or oversold condition, and be able to identify the trending mode of the market. After all, trading without a chart seems like an impossible mission, right?
Moreover, one of the key reasons why technical analysis works in forex trading is because the forex markets, unlike the equity markets, are open 24/7. Consequently, this creates clearer chart patterns and more trading data. Forex traders use these factors not only to trade in times of high volatility but also to use technical analysis tools when the markets are less volatile, which allows them to find good entry points and have extended periods to identify patterns and trading opportunities.
Another important reason why technical analysis is such a vital tool is that many forex traders keep an eye on the same levels and pivot points. This herd behavior phenomenon where individual traders create groups often helps them to identify the same candlestick patterns and collectively predict prices’ future direction.
“Technical analysis works precisely because people look at it. And if people care, I care.”
A true technical analyst will most likely tell you to forget about the theories and focus on technicalities, meaning to look and learn from real examples. Luckily, most retail investor accounts will provide trading platforms to enable trades using their built-in charting software and other analysis tools. Further, you can use a demo account to get familiar with the platform and explore the technical indicators offered by your trading platform without risking real capital.
In the next lessons, we’ll show you plenty of examples with different patterns and technical indicators, but for now, we simply want to show you how you can analyze a currency pair on a candlestick chart with basic indicators. So, let’s say we want to analyze the USD/JPY currency pair on a trading chart. For this purpose, you can use various charting software including the built-in charting package on the popular MetaTrader4 trading platform.
Now, once we choose the asset, timeframe, and the type of forex chart (line, bar, or candlestick) – you can then get all the historical data, identify chart patterns, and find entry levels.
Next, it’s time to add some basic indicators. What for? These technical indicators basically help you find important levels and understand the trend of the market. In the chart below, we added Fibonacci support and resistance levels and the Relative Strength Index indicator (RSI). That’s it. Clean and simple.
As you can see, the chart above shows us the USD/JPY price movement on a 15-min candlestick chart. In addition to these basic settings, we added Fibonacci retracement levels from the lowest to the highest price as well as the popular RSI indicator. With this simple display and only two technical indicators, you can easily interpret the pair’s trend and identify crucial entry and exit points. That’s what technical analysis is all about!
To sum up, technical analysis is a very wide subject with lots of patterns, indicators, and different analysis methods. And to the best of my knowledge, unless you have some special future predicting skills, you need to learn how to read and use a trading chart in order to analyze financial instruments.
So, to help you get all the necessary technical analysis tools, in the next courses, we’ll cover all the basics and advanced-level technical analysis topics. This includes types of forex charts, Japanese candlestick chart patterns, Fibonacci support and resistance levels, using moving averages in forex trading, and learning how to trade with multiple time frames. See you there!
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