What is technical analysis?
In order to earn on Forex, each trader strives to make as many profitable trades as possible. But how can one predict where the price will move? How do you determine market sentiment? One of the methods for predicting the price of an asset is technical analysis.
What is technical analysis?
Technical analysis is one of the methods traders use to study price movements.
Technical analysis is based on the trader's ability to determine the current trading conditions and potential price movement by analyzing historical price changes at different time intervals (5 minutes, 1 hour, 1 week, etc.)
All known trading information is included in the current market price. With the help of technical analysis, traders study the historical price movement in order to identify patterns and determine the probable future price direction.
For technical analysis, charts are used as an easy way to visualize historical data. Various technical tools are used to interpret this information.
Technical analysis does not guarantee that all of your trades will be profitable. However, it increases the likelihood of making the right decision.
How do you perform technical analysis?
- First, traders must determine the current trading situation on the market, namely, whether the price of the trading asset is rising or falling.
It should be borne in mind that the price has several states. First, it can be in an uptrend or downtrend. An uptrend is an increase in the price over a certain period of time. Vice versa, a downtrend is a fall in the price over a certain period.
The second state of the price is called a flat, or sideways trend, in which the price of the asset fluctuates in a narrow range of values.
Traders then look at past data on different timeframes to find similar patterns and identify trends and regularities.
The final stage is the correlation of historical data with current data. Traders make predictions, assuming that the price may act in the same way as before.
For example, if a certain price has been a major support or resistance level in the past, traders will monitor it and set their trades at that historical price level.
Which tools are used in technical analysis?
Technical tools come to the aid of traders to help them make more effective trading decisions. These tools include:
- trend lines
Plotting trend lines in Forex charts is an important part of technical analysis, which primarily helps to detect a trend. Trend lines show price movement during downtrends or uptrends.
- support and resistance levels
One of the most popular tools is the support and resistance levels. Levels can be plotted in the chart either manually or using indicators. A support level is a level below the current rate, where presumably the price might reverse up. A resistance level is a level above the current rate, where presumably the price might reverse down.
- graphic patterns
Graphic patterns are built to identify specific figures in the chart. Double Top and Double Bottom are examples of such patterns.
These instruments can be added to the chart either manually or using various technical indicators.
Technical indicators are tools used to analyze price charts. Most Forex trading platforms come with a selection of popular technical indicators. Each indicator displays certain information on the current price changes in the chart. Indicators are an important part of the trading strategy for most traders.
Advantages and disadvantages of technical analysis
Subjectivity. The fact that traders look at the same chart or indicators does not guarantee that they will come to the same conclusion about where the price will go. Based on personal experience, each trader has their own strategy and expectations, which can greatly affect the interpretation of data in the charts. Therefore, the entry and exit timing can differ significantly.
The limited character of information. Technical analysis is aimed at predicting a certain outcome for a chart pattern, while ignoring the fundamental reasons for the movement. For this reason, many traders use technical analysis together with fundamental analysis.
Different indicator readings. In some cases, one of the technical indicators can show a buy signal while another indicator shows a sell signal. This causes difficulties in making decisions.
Abundance of available information. The current price reflects all currently known information about the asset. While rumors that the price could plummet or skyrocket are possible, in the end the current price is the central basis for all information.
Fast decision making. Unlike traders using fundamental analysis, traders using charts have the opportunity to immediately see the slightest changes in the price of an asset and react in accordance with the chosen trading strategy.
Time saving. At the moment, there are a lot of different trading indicators that can quickly provide all the necessary information upon a trader's request. Thus, technical analysis takes less time than fundamental analysis.
Understanding of current market trends. First of all, with the help of technical analysis, you can quickly determine the current market sentiment. This information is of paramount importance to traders and allows them to make profitable trades.
We recommend using several types of technical indicators when forecasting prices, as well as taking into account fundamental factors for certain currencies. Technical and fundamental analysis are often viewed as opposing approaches to analyzing the Forex market. However, many experienced traders have achieved success combining both methods.
Article last updated: 2022-05-11