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Introduction to Technical Analysis
Technical analysis is the method used to study graphs to determine price movement. The theory behind this is that a trader can look at historical price movements to determine future prices since the market tends to repeat itself.
Basically what this means is that if a price level held as a key support or resistance in the past, the market (traders) will remember this level and base their trades accordingly. This way you can find probable directions of price by looking in the past for similar patterns.
Forex Market Technical Analysis Basics
Technical Analysis Basic Understanding
The Technical analysis method focuses on understanding the prevailing market trends and tries to pinpoint any reversal of this trend and predict how the Forex market is likely to behave in the future. It is more statistical in nature in the sense that this method relies heavily on historical data of prices and volumes traded using charts to understand and
interpret the market’s behavior. There are many mathematical tools available for making such analysis like various indicators, Number Theory, waves, gaps and trends etc.
Technical indicators for Technical Analysis help us in analyzing the following:
Identification of the trend for the currency pair
Whether the trend for the currency pair is bullish (uptrend) or bearish (downtrend). Or the currency pair is running sideways (range movement).
Strength of the trend for the currency pair
If there is a trend (up or down) then whether the trend has strength to continue or it’s weak, which may indicate that a correction or reversal may take place soon.
Resistance and Support levels
If the currency pair price is falling then at what levels we can expect support and expect a reversal to upward movement. And If the currency pair is having an uptrend then at what levels we can expect resistance and can expect a reversal to downward movement. For example let’s suppose a currency pair is having a trend (up or down) and the trend slows down. Our analysis says that the trend should continue but a correction in opposite direction may take place… but to what level? Technical analysis indicators like Fibonacci retracements indicates the possible retracement levels during a reversal or price correction during a trend.There are too many technical analysis indicators available with various online Forex trading platforms. Many theories exist and you will probably be familiar with Gann, Elliot wave and Fibonacci and many traders use them but there not scientific.
Technical analysis is underscored by three basic assumptions
The market discounts everything. That is to say all the happenings in the economy – let’s say the global economy – whether they are political events, statements by economic gurus, a security situation, crop failures or the collapse of a bank – everything affects the Forex market and has affected the prices prevailing in the market.
Prices move in trends. This means that there is a pattern to the price movements that needs to be studied. These price movements tell us something about the existing trends and allow us to make predictions.
History repeats itself. Mass thinking does not change dramatically over periods of time and the “wave” of mass psychological thinking moves in a familiar pattern. Only, the same needs to be understood and applied in practice.
The psychology behind trade activity and market psychology
The mental part of trading is just as important as the systems and indicators you utilize. I’ll explain here some insights from an excellent book for traders, Larry Williams’ Long-Term Secrets to Short-Term Trading.
Insight 1: “Why do most traders lose most of the time? Markets can spin on a dime and most traders cannot. Even the best traders (or the best trading systems) are going to be frequently wrong. That doesn’t negate the trader or the system – that’s just part of trading. The challenge for traders is accepting that the trade signal was errant. In a case such as this, Williams correctly points out that we’ve been trained to ‘hang in there’ and ‘have faith in our initial insight’, even if it’s clearly the wrong course of action. That’s just our ego needing to be right so badly that it will often ignore the exit signals that warn the trader of the impending problem.
Insight 2: It’s not the trade, it’s the battle. Too many traders believe that their last trade is a reflection of just how good of a trader they are (but they are the only ones who feel that way about themselves). This boils down to one word – expectation. If you expect to win all the time, or even the vast majority of the time, you’re setting yourself up for a lot of heartache. That frustration, though, is the very same force that will truly make your negative perception of yourself a reality. And even a good trade can be damaging if you let it warp your disciplined approach. The fact of the matter is that this is a game of odds, and should be played over a long period of time. Focus on the war – not the battle.
Insight 3: The amount of (or lack of) evidence for a market move does not make the move any more or any less likely. All traders, but especially new traders, have one of two problems. They either buy too soon, or buy too late (and in reality, when it comes down to it, those are the ONLY two problems in). The first problem of buying too soon is a sign of not wanting to miss out of any of a move. Of course, if you jump in and the move never becomes a reality, the trade suffers. The second problem is the opposite – the trader wants to make sure the move is going to happen, so he or she will wait for all the right signals to verify that the move is for real. Of course by that time, most of the move is behind you. While it’s easier said than done, one has to find a balance between those two extremes. In this case, the best teacher is experience.
Insight 4: What’s the difference between winning traders and losing traders? Well, first, there are a few similarities. Both are completely consumed by the idea of trading. The winners as well as losers have committed to doing this, and have no intention of ‘going back’. This same black-and-white mentality was evident in their personal lives too. But what about the differences? Here’s what Williams observed: The losing traders have unrealistic expectations about the kind of profits they can make, typically shooting too high. They also debate with themselves before taking a trade, and even dwell on a trade well after it’s closed out. But the one big thing Williams noticed about this group was that they paid little attention to money management. To me, the mind is where the biggest battle will ever take place for a trader. In this game, you can easily become your own worst enemy if you don’t keep your emotions in check at all times. Some experts would say that after your trading strategy has been defined and the risk management principles are put in place, trading then comes down to as much as 90% psychology. Only we can stick to our plan of action and remain calm, unemotional and patient during the peaks and troughs the markets have to offer.
Understanding Moving Average
The Moving Average (MA), as an instance, is one of the most common and powerful technical indicators. It computes the average of prices over a specified period of time. An image exemplifying this indicator is provided in appendix A. The most useful way to apply the moving averages is to find a good relationship with the price. When the price crosses over a certain moving average could be a signal to buy while a signal to sell could be the opposite. Similarly the moving averages could generate buy/sell signals by crossing over each other.
Understanding MACD (Moving Average Convergence/Divergence) indicator.
The MACD (Moving Average Convergence/Divergence) indicator is one of the most trustworthy and simple to use technical indicators. This indicator is comprised by the plot of a “Fast” line and a “Signal” line. The “Fast” line is computed by obtaining the difference between two moving averages. The “Signal” line is computed from the “Fast” line and both are plotted in a single plane. Using a 12 and 26 period exponential moving average for the “Fast” line and a 9 period exponential moving average for the “Signal” line are the typical set up for this indicator. Similarly to the moving average indicator the MACD also signals buy/sell moves from crossovers between its two calculated lines previously described. Additionally, the MACD uses divergence and convergence with the price for profitable trades.
Understanding Stochastic Oscillator indicator
The Stochastic Oscillator indicator in Forex finds market momentum and it is composed by %D and %K, which are two oscillator lines. These two lines are computed by a formula that can be found in appendix A. %K makes a comparison between the latest closing and the recent trading range and %D is just a simple 3-day moving average of %K. It is recommended to buy when this indicator has an oversold reading which is below 20%. On the other hand, an overbought reading, above 80%, indicates to go short. The stochastic oscillator directs to a trend fatigue and change. In other words, a trader all the time enters on pull-backs, assuring safe stop loss levels.