What is Technical Analysis?
Have you ever wondered what traders mean when they talk about Technical Analysis? If you answered yes, then this article is for you.
Now, it is true that there are probably as many trading strategies as there are traders. However, for the most part, all strategies used by Forex Traders fall into two main categories.
These two categories are known as Technical Analysis and Fundamental Analysis. So, in a nutshell, what is Technical Analysis?
Technical Analysis is a methodology that attempts to evaluate and anticipate the future direction of financial assets by studying it’s historical price chart(s).
Between Technical and Fundamental analysis, the most popular one is by far Technical Analysis. However, being more popular does not necessarily make it more important or more effective.
In this article we will attempt to provide some basic information on what Technical Analysis is, and how traders use it in Forex Trading.
A quick look at Fundamental Analysis
As stated above, the two main methodologies used to trade the forex market is Technical and Fundamental Analysis. So, in a nutshell, what is Fundamental Analysis?
Fundamental Analysis is a methodology that attempts to evaluate and anticipate the future direction of financial assets by studying their underlying economic climate and outlook.
Fundamental analysis uses economic data to get a picture of how different economies are performing against each other. This information is then used to establish good probability currencies to pair against each other for trading opportunities.
Some of the things considered in Fundamental analysis are Currency Exchange Rates, Interest rates, Inflation, Geo-Political factors, Economic Growth indicators, Economic Production Indicators, Economic Employment Indicators etc.
Furthermore, fundamental traders need to do this analysis not only for one currency, but for both currencies in a currency pair. Traders also need to interpret the data correctly in order to forecast where the price is most likely to go.
Think of Fundamental Analysis as the underlying reasons for why the market is moving the way it does and in the direction it does.
Fundamental Analysis can be used to forecast short, medium and long term price moves. Day traders who use fundamentals use their skills in order to establish what the current sentiment is in the market.
This sentiment can last for hours, days or even weeks in some cases.
Technical Analysis explained in a bit more detail
On the other hand, Technical Analysis only looks at the price charts itself. It uses the historical price charts and price movements to to analyse in which direction price is most likely to move
Some forms of Technical Analysis makes use of various technical indicators to help traders interpret potential price movements and directions.
Price Action is also a form of Technical Analysis in the sense that it only uses price charts. However, where Price Action differs is that pure price action traders normally don’t use any technical indicators.
Traders that uses clean price charts normally solely rely on the price movement to evaluate and anticipate possible trade directions.
Why is Techincal Analysis so popular?
Most beginner traders almost fall in love with Technical Analysis immediately. They are amazed that traders are able to anticipate future price moves by simply following the signals given by technical indicators.
New traders are drawn to Technical Analysis because it is something mechanical. The reason why mechanical trading systems are so attractive is because they are very easy to implement.
Most purely technical based systems have a bunch of checklists and rules. New traders absolutely loves these rules and checklists because they think it will protect them from the uncertainty in the market.
Also, new traders lack market experience and thus like the idea of just blindly following indicators to tell them what to do next.
Another reason why so many traders like Technical Analysis is because it is much less work compared to Fundamental Analysis. However, the biggest culprit for the popularity of Technical Analysis is false advertising.
There are thousands and thousands of trading systems for sale on the market for ridiculous amounts of money. The people promoting these systems promise instant riches and success if you simply buy their trading system.
Do not fall victim to the lies these people spread. There is no such things as the perfect trading system. If it was that easy everybody would be doing it.
Reality check about Technical Analysis
The love for Technical Analysis is soon remedied when beginner traders realize that it’s not quite that simple. Beginner traders normally find out the hard way that Technical Indicators cannot predict, they merely indicate.
There is no indicator or indicator based system that will ever be able to predict where price will move to next. Technical Indicators can mere indicate where price might possibly go based on their mathematical equations.
In our opinion, less is always more when it comes to Technical Analysis. The simpler your Technical approach is the better.
Before you invest in another Technical Indicator, rather sharpen your Price Action skills such as order flow and supply and supply and resistance.
In our opinion, majority of the indicators out there will just show you what is already clearly visible in the Price Action of the chart.
Let us look at the chart below as an example:
Did you really need three different moving averages to tell you that this chart has upward momentum.
Similarly, did you really need an oscillator to tell you that the market is making impulsive and corrective price movements?
Also, if you blindly followed this technical indicator you would have lost out on a 1000 pip move. Even more, if you blindly followed Technical Analysis you might have taken sell trades against this obvious up trend.
You did not need all of these indicators to tell you what was happening on the chart. Interestingly, the Fundamentals were clear on why the EURUSD had such bullish momentum during July of 2017.
The Fundamentals could have kept you from taking any sell trades during that time on this pair.
So how can traders use Technical Analysis in their trading?
In our experience, less is always more when it comes to Technical Analysis. You don’t need fancy and elaborate Technical trading systems that will cost you thousands and thousands of dollars.
You also don’t have to have hundreds of Technical Indicators on your charts. We have been there and done that.
At the end of the day the simplest approach is normally the best approach when it comes to the Technicals.
One of the most basic and useful Technical Analysis tools is Support and Resistance levels.
The best part is you don’t even need any fancy and overpriced Indicators to draw them.
Support and Resistance
This is probably one of the most useful elements in Technical Analysis. It can help tremendously with trying to establish good areas to place stop loss and take profits.
It will also help a lot with order placement as it will help you see when order levels are too close to important price areas. So, in a nutshell, what is Fundamental Analysis?
Support and Resistance refers to historical areas or levels on price charts where the market has previously reacted from. Support and Resistance areas or levels are interchangeable, meaning they can act as both Support and Resistance for the price.
For those of you who are very new to trading, this concept will be better understood by looking at a chart.
The chart below will illustrate what we mean by Support and Resistance areas or levels:
The chart above is a good example of Support and Resistance levels and areas. You see, these levels are not strict levels, they are more like zones or areas.
These levels and areas are used as a way to anticipate how price might react when it reaches one of these levels. For example, there is a higher probability that price might bounce upwards when it reaches a support area.
Similarly, there is a higher probability that price might bounce downwards when it reaches a resistance area. However, these levels work with probabilities.
This means Support and Resistance levels are not perfect and they won’t work all the time.
Sometimes, price will move through Support and Resistance levels like there was no level at all.
Below is an example how Support and Resistance might be incorporated in trading:
Supply and Demand (Order Flow)
Order flow or supply and demand is another great Technical Analysis method. So, in a nutshell, what is order flow in terms of trading?
Order flow in Forex Trading refers to the price movement and price direction based on the supply and demand flow of currencies.
If this sound a bit confusing don’t worry. The visual example on the chart below will help to better illustrate this point…
The Order Flow shows us what type of Supply and Demand there is on individual currencies. It assists traders in evaluating when the flow in the market is changing.
Order Flow is also very handy by helping us to trade in higher probability trading directions. Essentially, you don’t want to be trading against the flow of the market.
A view final thoughts on Technical Analysis
Technical Analysis is a valuable method used for trading in the Forex market. When used properly, it can give traders very accurate information.
Using Technical Analysis properly can warn traders to stay out of bad trades. This is especially true when it comes to entry and exit locations on the charts.
This methodology is incredibly helpful in understanding how the market is viewing certain currencies based on the Order Flow.
Don’t over complicate your life by relying on indicators to tell you where the price might be going. In our opinion, relying solely on Technical Analysis without fundamental analysis will cause lots of frustration.
For us, knowing why the market is moving is more important that knowing how the market is moving. However, solid Technical Analysis skills are absolutely crucial and essential in your trading.
Knowing why the market is moving will not help you plan and execute your entry and exit locations. Only Technical Analysis will help you to do that.
As always, our advice is to invest in a forex education before risking real money in the markets. Also, don’t risk real money until you have proven you can trade successful with a demo account.
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