2.15 Technical Analysis
Forex technical analysis refers to the analysis of the price action of a currency pair without getting into the nitty-gritty of the economic trends and facts. In a speculative market the prices change every moment. These continuously changing prices do not reflect the change in the fundamentals of the economies as the fundamentals do not change every minute. This continuous volatility is because of a continuously changing demand and supply situation. In the dynamic Forex market, analysis of the price action is a continuous process for both entry and exit.
Simply speaking the concept of technical analysis is all about determining the future trends based on the historical price-action. Ideally, the price movement in the Forex market should be driven by the health of the economy of the country/region and the demand and the supply for a particular currency for business transactions. But when the currency pairs are traded as speculative financial instruments, technical analysis comes handy to analyze the ongoing market moves
Technical analysis is a study of market behavior usually using charts for:
- Assessing the existing market situation
- The likely amount and direction of the price movement in future
Technical analysts rely on this information for their study:
- Price action over the time and with different time frames
(*In the spot FX market, because of its OTC (Over The Counter) nature, volume data is not readily available.)
Basic assumptions of technical analysis:
- All information there is to know is already known by the market and is reflected in the price. What it means is that we have put a lid on the jar of fundamentals and have put that jar in the corner. We are only considering the price movement over the time and how the market may behave in the future, based on the past movement.
- Prices tend to move in trends, and these trends will more likely continue than take some correction or reverse.
- History repeats itself. This is because human psychology comprising greed, fear, hope and ignorance reacts much the same way throughout time –creating predictable patterns on the charts.
Technical analysts look at the chart of a currency pair and see what happened at crucial price points of support and resistance and attempt to predict what the price would do when it again approaches those points.
Another point to note is that as more and more people learn and take up technical analysis, key price levels which act as support and resistance get reinforced further. Thus technical analysis may get credit for something that really was just a self-fulfilling prediction because so many traders and analysts believed in that level.
Lastly we would like to point out that technical analysis, at the end of the day, requires a lot of interpretation and may be somewhat subjective. The result – one analyst’s views may be quite different from another!
Using Complementing Tools for Analysis
Technical analysis is for gauging the trend situation, identify the entry and exit points and also to estimate the stop-loss order levels. In simple words you can say that it is used to identify the trend and support & resistance levels. It is always better to make trading decisions not only based on a single technical indicator but on a combination of complementing indicators. For example one indicator may be used to judge the trend situation, and another to decide on the entry, exit, stop-loss levels, and take-profit targets.
While we mentioned combination of indicators, please note that we indicated "complementing indicators". It’s always advisable to avoid the use of multiple indicators for reconfirmation purposes. Using multiple indicators for the same purpose only creates confusion and make the decision making complicated. Keeping it simple always pays off better. By the way the complementation is not only about using multiple indicators but by using various tools like chart patterns, pivot points, changes is correlation coefficients etc. Don't worry, all these will be covered in subsequent lessons.
- Technical Analysis