Technical analysis is a strategy used by most professional traders in which they carry out an examination of past price movements so as to forecast possible price movements in the future. This type of analysis assists traders to get the big picture of historical price movements in order to find the best trading opportunities. Technical analysts concentrate on the study of charts in order to predict what is “likely” to happen to prices in the future.
Technical analysis is based on the following assumptions:
- All fundamental conditions are reflected in price data
- The prices of currencies move in trends
- History repeats itself
Traders using technical analysis in forex trading hold that the macroeconomic condition affecting the value of currencies are reflected in price movements. Thus, they only concentrate in the study of charts to trade forex.
Technical analysts believe that the fluctuations of the prices of currencies do not take place in a disorderly fashion, but they are systematic and predictable. Once a pattern has been established, price will tend to move in that pattern before changing to another one.
Technical analysts study historical price movements because they believe that price tend to behave the same way it did before. For instance, if a price level held a strong resistance area in the past, they will observe if the area is either held or broken before placing their trades in the market.
There are five groups in technical analysis:
- Number theories
Currency prices are classified in three ways: upwards, downwards, or sideways trend. And, technical analysts examine the charts to spot any of these trends to identify possible trading opportunities.
In the foreign exchange market, indicators are used for giving a graphical representation of the movements of prices. Indicators are either leading (give trading opportunities before trend is established) or lagging (give trading opportunities after the trend is established). Examples of leading indicators include Stochastic, Parabolic SAR, and Relative Strength Index (RSI) while examples of lagging indicators include Moving Average Convergence-Divergence (MACD) and other moving averages.
Technical analysts believe that the fluctuations of currencies prices take place in systematic and foreseeable “waves.” The common technique used in this is the Elliot Wave theory.
Gaps are places in the graphs which do not have any trades, and they are often traded by looking at high-low and open-closing prices.
These are used for predicting potential price movements in the future. Examples are Fibonacci numbers and Gann numbers.