Technical Analysis“Give me your palms and I will tell you the future” so said the palm reader. Forex technical analysis simply involves studying the market price action and trying to predict the future prices of currencies. In a nutshell the goal is trying to predict future price action based on past price actions. Technical analysis borrows a lot from the Dow Theory which had three underlying assumptions: 1. Market action discounts everything 1. Market Action Discounts Everything The first time I heard this, I had to work my brain a bit. I was so used to being told that the price of oil was going to go up because the supply was expected to go down. I expected that for the same reasons the price of a currency would go up due to demand/supply factors in play. However, technical analysis assumes that the price seen on the trading charts is the one and only price that matters. Using the technical approach means that the price you see on your trading chart has factored all the reasons that it can go up or down. The pure forex technical analyst looks at the trading charts as a doctor would look at an x-ray. What you see on your chart is what you get. This is one of the main reasons that a pure technical analyst has no time to watch the news ticking in. It is assumed that the market already knows the news and has already reacted to it and the result is the price that he is seeing on his chart. One of the best examples of such trades is before the USA Central bank releases its interest rates for the quarter. A lot of "technicians" are busy predicting what the USA dollar will do after a certain rate change. Other traders are busy preparing to make a killing in any market spikes after the report. The report comes, and there is no significant movement in the prices. The price of the dollar after an initial spike continues in the trend it was before. Technicians believe that prices move in trends. A trend can be explained as the general direction that currency prices are taking. Think of a river that is flowing from the hills to the ocean. It basically flows from the top of the hills to the lows of the ocean valleys and as such you can say the general trend of a river is downwards. The trend in forex also assumes that there are 3 different trend types: primary trend, a secondary trend and a minor trend.
The Primary Trend
It was mentioned earlier that the river will generally flow from the top of the hill to the bottom of the ocean flow. So the primary trend of a river is down. This is because of the years it has taken to create valleys and troughs through which the water will flow. In technical analysis we also have the primary trend. The primary trend might take years to develop. At times I tend to look at yearly charts to see what the primary trend of a currency is. If we take the EUR/USD currency as an example we can see that since its inception, it has generally been going up as the European currency gathers strength against the USA dollar. So we can assume that the primary trend of the EUR/USD has been up. The Secondary Trend Nothing goes up in perpetuity. Over the years that the EUR/USD has been gaining strength, there have been periods when the opposite is true. The secondary trend usually lasts a shorter period than the primary trend. From days to months and can be strong enough to become a primary trend as oil has done over the past 2 years. The Minor Trend This lasts for only days and is significant to day traders who live off trading daily trends. Long term traders view minor trends as just hiccups as the market gets ready to move again in the direction of either the secondary trend or the primary trend. So in technical analysis you, the trader, will have to identify the trend you are trading in so as to get the most profits. Once I started knowing my trends, it became easier to figure out how to profit from forex trading. Trying to identify the trend is the main duty of a forex technical trader. 3. The Historical Price Action of a Currency will tend To Repeat Itself This is the bread and butter of forex trading systems. The forex technical analyst assumes that price action will tend to repeat itself as human beings are programmed to do the same things over and over again especially if they are working. The concept is simple, if I say no to someone; they are likely not to be happy in the short run. In the same way if the price of a currency reaches a particular level and goes no further, technical traders will assume that it will not pass that level again until something significant happens. This is where the use of trend lines, Fibonacci numbers, support and resistance lines etc come in (these are all covered a bit later). The underlying idea is that the technical traders believe that some prices are so significant that traders on reaching these prices will tend to trade the same way over and over again. So the technical analysis involves looking at the history of price actions and see how traders traded those levels and assume that the next time prices get to those levels, the market will behave the same way. It has taken a long time for technical trading to be accepted as a tool for forex traders. However the success of some forex technical traders has started a revolution where even fundamental traders tend to learn a bit of technical analysis. Whether it is all group think and hallucinations is anyone’s guess but I can attest to technical trading making me a very happy forex trader indeed. Top of: Technical Analysis Page Back to: Learn Forex Trading Page Back to: Forex Trading Domain Homepage
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