In the past, fundamental analysis used to dominate forex market. Until mid-1980s, when there was no sophisticated trading tools and platforms, investors was primarily trading based on the fundamental factors. However, following advancement of new technologies, technical analysis in forex market has become more popular. More traders joined to the ranks of technical approach by utilizing chart patterns and indicators more frequently. Thus the impact of technical analysis on the forex market has increased remarkably and if you want to become a profitable forex trader, you have to get to learn technical analysis.
Technical analysis concentrates on the study of price action. This type of market analysis use historical data to predict the direction of prices movements. The main premise of technical analysis is that all necessary information to forecast future price action is already reflected on the price chart. Therefore, studying price movements and price chart is all that is required to make high probability trading decisions.
Technical Analysis in Forex Market
Since majority of the long term trends are generated by fundamental factors such as GDP, interest rates and politics, technical analysis could prove very useful when utilized for short term to medium term trades. It complies well with the forex market because majority of short term price movements are driven by human emotions and market sentiment.
The most important tool in technical analysis is price charts. Technical traders use price charts to detect trends and patterns so that they can find profitable trade opportunities. In addition, technical analysis tools such as chart patterns, Fibonacci levels, Moving Averages, RSI, Stochastic, candlestick patterns and Bollinger Bands are used by forex traders to get further information about direction of the trend, overbought and oversold levels, support and resistance levels.
One of the biggest benefits of using technical analysis is that it provides traders an understanding about the psychology and sentiment of the market participants. Humans tend to leave clues about their emotions on the price chart and technical analysis is the best tool so far to identify them. Even though, the market participants may change over time, human emotions and human reaction to certain events doesn’t change. Technical approach is used to exploit this fact.
Assumptions of Technical Analysis
There are three assumptions which the technical analysis is based on.
Market Discounts Everything
This assumption probably composes the most important pillar of technical analysis. Unless a trader fully understands and acknowledges this basic premise, he / she won’t succeed at using technical analysis to predict future price moves in the forex market. The technical traders believe that any fundamental factor that can have impact on the price such as political instability, economic releases, interest rates, etc. are already manifested in the price on chart. Therefore analyzing price movements is all that a trader needs.
This argument, which is called Efficient Market Hypothesis, nullifies the claim that technical analysis is only based on price action and doesn’t reflect fundamental factors. The technical traders presume that price chart contains the effects of fundamentals on the supply and demand for the related currency.
Prices Move in Trends
The concept of trend is crucial for the technical analysis. The technical trader believes that price of an asset moves in short, medium or long term trends and main purpose of charting the price movements of an asset is to recognize a trend. A trader profits if he / she is on the right side of the trend and loses if he / she is on the wrong side. Most of the tools that technical analysis employs aim to identify current trends and predict future trends.
History Tends to Repeat Itself
Since majority of trades on exchange market is transacted by humans, it is essential to study human psychology in order to become a profitable forex trader. When you look at a price chart, you are very much likely to see some patterns that repeat itself. This repetitive feature of price action is associated with traders’ emotions like excitement, dismay, anxiety and fervor.
These emotions has been around for thousands of years and not likely to disappear in near future. Technical traders utilize chart patterns which are formed as a result of the human emotions and attempt to predict future trends to make profit in the forex market. In very simple words, technical traders believe in the notion that future relies on the study of the past.