What does technical forex analysis consists of? It studies past price and volume movements and from that data creates charts that can be used to take strategic decisions. It looks clear how technical analysis does not take into consideration events that might affect the forex market and that are highly considered in the fundamental forex analysis.
The actual forex rates are a reflection of a combination of factors such as supply and demand conditions, political factors, and market sentiment. All of these factors are included in technical forex analysis, but are not explicitly expressed and therefore we might risk to not understanding a certain trend in interest rates without knowing the scenario that caused it. If you decide to use technical forex analysis to take strategic decisions make sure to look into forex interest rate changes and understand what caused them.
Introduction to Forex Technical Analysis Explained In recent years, technical analysis on Forex has gained popularity not only for its relative simplicity but also for its universal approach. This means that it can be applied to all market segments and to different time frames. Many modern trading systems of large financial funds and commercial firms are based on technical analysis.
Therefore, both professionals and beginners can use it as a starting point in their trading. In this article we will learn the basics of the technical analysis, will discover how charts can be analyzed, as well as will quickly go through the history and the main stages of the development of technical analysis. What is Technical Analysis?
Technical analysis is the analysis of price changes by charts to determine the direction of price movement in the future. It is based on 3 sources of information: prices, trading volumes, and time. Unlike the fundamental analysis, there is no information about the reasons for price behavior.
It already takes into account the price movement in one direction or another and, based on certain identified patterns in the past, allows us to spot the occurrence of certain events, namely the rise or fall of prices in the future. Using graphical patterns, trading volumes, participants' activity, and other points, a technical analyst tries to identify stable trends, find real resistance and support levels, as well as possible points of a market trend reversal.
The Origins of Technical Analysis The technical analysis appeared almost immediately with the beginning of trading on the stock market. At all times, people have sought to buy cheaper and sell more expensive, and have been looking for the right time to do so, trying to analyze the dynamics of price changes. The earliest mention of technical analysis dates back to the end of the 19th century when Charles Dow himself published an article in the Wall Street Journal in which he outlined several principles with which he believed it was possible to enter into buying and selling deals with minimum risk.
These principles were later incorporated into the theory of determining the direction of the stock market. At this point, the talk of technical analysis has subsided. There would be no happiness but misfortune helped: in the Great Depression broke out, which, strangely enough, opened new horizons for "technicians". That decade was marked by the publications of such legendary stockbrokers as Elliott, Wyckoff, Gunn, and many others.
However, there was no single vector of development: at that time some considered charts as a graphic record of exchange supply and demand, while others were searching for "secret order" at the exchange. The results of the research were the Elliott Wave Theory and the works of William Gunn, who created a complex combination of geometric-algebraic principles, which traders successfully used in derivatives markets.
With the advent of computers in the '70s, technical analysis began to take a more mathematical form: analytical methods began to develop with great speed using mathematical approximation and filtering. This included the creation of Widler's Guidance System, which allowed trends to be detected and determined by their speed, and a huge number of indicators.
Although, it should be noted that there is also such a direction of modern technical analysis as Price Action, which rejects the use of indicators and is fully based on the visual analysis of price charts which, in a certain sense, is nothing but a return to the roots. Does Technical Analysis Work?
The effectiveness of technical analysis on Forex market can be explained quite simply. A huge number of traders all over the world using technical analysis see the same charts, models, and figures using the same indicators and oscillators. And as soon as there is a signal that technical analysis interprets as a signal to buy, the majority of traders start to buy.
As a result, the price starts to go up. If you need to sell according to the technical analysis, then many people start to sell, which pushes the price to the bottom. And the stronger the signal, the more players enter the game. There are several hundreds of different indicators in the world, based on which we can derive an assumption about further price movement.
And the more people use this or that indicator, the more effective it is. Therefore, over time, the number of traders is smeared by these indicators, which ultimately reduces the effectiveness of each indicator. Therefore, the most effective is considered the simplest but strong models and only a few basic indicators, which are used by most players in the market.
The explanation is also quite simple. Most traders learn only the basics of the analysis, which is quite enough for them to trade. Forex technical analysis is similar to statistics and public opinion polls. Its main purpose is to reveal the crowd's mood or balance of forces and take the side of the majority. In the case of bullish moods to buy, in case of bear ones - to sell. If the task is to predict future prices, then it makes sense to focus on current and past price movements.
Often, the reaction and price movement occurs earlier than the fundamental reaction. It is believed that the financial market is the leading economic indicator and that it "leads" the entire economy of the country, ahead of months. And to keep up with the market, it makes sense to focus on price. But we should not forget that the changes in the market are very insidious. And although the market can present sharp indirect surprises, as a rule, you can recognize the signs that predict this or that change.
Technicians call an accumulation period, a period that foretells a rise in prices, and a distribution period, a period that foretells a fall in prices. Many technical analysts use opening, closing, maximum and minimum prices when analyzing an asset. Each of these four prices has useful information.
Separately, they will not tell much about this asset, and together - 4 prices can clearly show the behavior of supply and demand in the market. Thus, operating with these four, we can observe the struggle between supply and demand. Simply speaking, increasing-price means increasing demand and decreasing price means increasing supply. Support and resistance. Simple Forex technical analysis of charts will allow us to see the support and resistance lines.
They can be easily seen by price accumulations in a certain closed imaginary corridor. Such price behavior indicates that supply and demand are at an impasse. As soon as the price goes beyond the aisle of the corridor, it means that either demand or supply has "won" the fight for price.
If the price has risen above the upper line of the corridor resistance , it has won the demand. If the price has fallen below the bottom line support , the supply has won. Graphic display of the price. Even if you are a supporter of fundamentalism, an illustration of price history will give you a lot of useful information. The chart is a simple and convenient way to display the price history of an asset.
A chart is much more convenient than a table with numbers. Most charts show the trading volume. Market Entry. Technical analysis on Forex allows choosing a good time to enter the market. Some analysts use fundamental analysis to decide what to buy, and use technical analysis to decide when to buy. It is not a secret that time calculation can significantly affect the yield. Technical analysis will detect demand support and supply resistance and turning points.
Even if you just buy near the support line or after breaking the resistance line, it will significantly increase your profits. It is also important to know the history of the asset. If you thought that the instrument has been growing over the last years, but in reality, it has not, then you can make a big mistake. For example, if the instrument has already shown its maximums, it would be logical to expect a price decrease.
Or if the stock falls, it would be logical to wait until it reaches the minimum and turns around. Disadvantages of Technical Analysis: Analytical interference. Like fundamental analysis, technical analysis is very subjective and therefore interference is reflected in the analysis results. It is important to keep this in mind when analyzing charts. If, for example, an analyst is a buyer in his life, he will see signs for buying where they may not exist. If the analyst is a seller, the interference will be in the direction of selling.
Doubtful conclusions. Based on the same analysis, you can draw different conclusions. Perhaps, this phenomenon is one of the most serious shortcomings of Forex technical analysis. Even though there are generally accepted standards, often two analysts can see different trends on the same chart and both will find confirmation of their conclusions, and they will have the right logical reasoning. Too late. Often technical analysis is accused of giving signals too late.
Advantages of Fundamental Analysis: Business background. One of the most obvious advantages of fundamental analysis is that fundamental analysis provides a very good understanding of enterprises and business in general.
After such a thorough analysis, investors will be able to see through the companies. You will be able to determine what exactly affects the income of a given company, or where it has the weakest link. The experience of fundamental analysis will allow you to identify companies that are likely to go bankrupt shortly, as well as those that are focused on long, hard work and success.
Moreover, the experience of a fundamentalist will open up in you the skills to identify the drivers of entire sectors, spheres, and industries. Valuable discoveries. A good fundamental analysis allows you to discover valuable stocks, i. Many investors are looking for valuable assets and are willing to wait long enough for them to prove themselves. It is a fundamental analysis that helps find companies with powerful assets, strong balance sheets, stable earnings, and growing profits.
Long-term investments. Fundamental analysis is ideal for long-term investments. It provides an opportunity to predict long-term economic, demographic, technological, and consumer trends with high probability, thus helping investors to find good tools for long-term investment. Considering that Forex technical analysis is not so good for long-term investments, this specificity of fundamental analysis is a serious advantage. Disadvantages of Fundamental Analysis: Limited time. Fundamental analysis can trace the internal life of companies, industries, and the market in general, but thorough fundamental analysis takes a very long time.
Special approach. One of the drawbacks of fundamental analysis is the need to be tailored to each company. The methods of fundamental analysis may vary depending on the industry and the unique factors of a particular company. Therefore, each industry and each company requires its unique approach.
The next drawback of fundamental analysis is the hope for a certain outcome. The fair value of a share is based only on assumptions. Often, fundamentalists are aware of such mistakes and perform analysis in three modes. Determination of fair price.
When the share price reaches a maximum or minimum , there is a desire in the market to adjust the price or bring the share to its fair price. The fair value of a security is determined by the price you are willing to pay for it. Technical Analysis Basics Price action discounts everything This is a fundamental principle: we understand that the price is formed based on millions of different factors remember the "butterfly effect"?
But we cannot take into account all these factors, so we assume that these factors have already been taken into account, all of them. The price established in the market is the same indicator with which all the factors have been taken into account. Even without understanding their influence, and without knowing about them, we can see the final effect of their influence, embodied in the form of price fluctuations.
Accordingly, by analyzing price dynamics, we can make assumptions about how this price may behave in the future. It is the technical analysis that tells how to predict the future movements of the chart, not analyzing the underlying causes and motives, but studying only the dynamics of the chart itself.
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Now you might be asking yourself a simple question: I understood the meaning of fundamental forex analysis. Still, I am not an expert trader and therefore I do not know any other valuable economic indicators. Can you give me some more examples? This is a fair question. PaxForex suggests looking at the following economic indicators while analyzing assets: Interest rate announcements Consumer price index Trade balance number The importance of a given index is based on everyday news and therefore no indicator has a fixed level of importance.
For instance, if you read a news report about growing inflation in the United States, the consumer prices index will acquire more importance and therefore have a big relevance in the forex market. Fundamental forex trading is not as straight forward as it might seem since it does not lead to standard behaviors of traders. What we mean here is the fact that if there are news leading toward a certain expectation, it does not necessarily mean the market is going to move accordingly.
This is due to the fact that the same news will be available to all traders and therefore the currency switches from being exposed to the news to being dependent on how traders will react to the news; which is mostly unpredictable. At the same time, predicting the right movement can represent a great source of income.
The shooting star from the previous session was a sign that perhaps we were going to see some problems, and now it looks like that is starting to come to fruition. The real question at this point is going to be how the market determines whether the level is being supported or not.
If we break down below there, we could go down to the level over the longer term. The alternate scenario is that we somehow turn around and take out the level, which would be a bit of a coup for the bullish traders out there, opening the possibility of a move to the handles.
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