What is Technical Analysis
Forex Traders use many different aspects to assist them in making their decisions on whether to buy or sell. There are probably as many methods to trading as there are traders. This article provides basic information on what Technical Analysis is and how traders use it in Forex Trading.
Technical Analysis vs. Fundamental Analysis
There are two main methods traders use to analyse the direction price is most likely to go. These two methods are namely; Fundamental Analysis and Technical Analysis.
The first one mentioned is Fundamental Analysis and is the more important of the two. When referring to Forex the fundamental analyst needs to observe, understand and interpret elements such as; Quantitative Easing, 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. Fundamental Analysis can be used to forecast short, medium and long term price moves. What most traders don’t realise is that Fundamental Analysis works just as well in the short term if you know how to use it. 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 extreme cases.
Technical Analysis, on the other hand, only looks at the price charts itself. It only looks at the price chart 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 the price movement.
Price Action is also a form of Technical Analysis in the sense that it normally only uses price charts without the use of technical indicators. Pure Price Action Traders normally solely rely on the price movement on the charts to evaluate possible trade directions.
Technical Analysis in more detail
How does Technical Analysis use the price charts to tell us what direction the market most likely wants to move? The first element that Technical Analysts use is the chart itself. Traders will make use of various things such as trend lines and support and resistance levels to estimate possible areas where the price is likely to react. Price Action traders normally use support and resistance levels as the backbone of their trading methodology.
Secondly, Technical Analysts use various indicators on their charts to give them an idea of where price might be heading next. Traders use different indicators to interpret different things in the market. For example, when a trader evaluates whether a trend is gaining or losing momentum they can make use of moving average indicators to assist them. If they want to establish how far a trend might be going they can make use of range indicators and various oscillators.
Traders might also want to establish whether a trend is entering into a possible correction or reversal area. For this, they also make use of various oscillator indicators such as the Stochastic Oscillator or the Relative Strength Index. Traders also use these indicators to establish if price is entering into an overbought or oversold area. They also use the oscillators to give them better signals for entries and exits.
The Pros and Cons of 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 of possible future price movements. This includes trend continuations and reversals. Technical Analysis indicators can warn traders to stay out of bad trades and notify them of good ones.
However, indicators can only do what their name implies, which is indicate. They cannot and will never predict where price will go! They can merely indicate where price might be going next. For this reason, many traders use Technical Analysis incorrectly. They think the price must do what their indicators shows them.
There are many traders who prefer to trade without the Technical Analysis indicators all together. These Pure Price Action traders only rely on the movement of the price and the way it acts to show them how and when to trade.
There are also many traders who choose to combine the simplicity of pure Price Action with Fundamental Analysis. These hybrid trading methods are normally much more successful in determining trade direction when they are used correctly.
Traders who only rely on technical analysis without fundamental analysis is missing a crucial part in our opinion. There are no amount of indicators that can replace the importance of fundamental analysis.
At the end of the day, these technical analysis methods are just tools to help us in our trading. Every trader should discover which methods speaks better to their own personality. Each trader will adapt better to certain trading styles and Forex trading strategies. It is up to you to discover which method will work best for you.
Personally, we are of the opinion that no trader should ever try to trade the markets without the help of Fundamental Analysis and without having some good Price Action skills. For us, the Fundamentals tell us why and where the market should be moving, and the price action tells us where and how to enter and exit our trades. We need both of them to trade successfully.
As always, our advice for any trader is to invest in a Forex Trading Course before risking real money. in the markets. Good Forex Training should include all of these elements mentioned above in their analysis. This will help you to make your decision of what methods to use according to your strategy and preferred trading style.