Technical Analysis in Forex Trading

Introduction

There are two main approaches used to analyze and decide when to buy or sell in the market. These methodologies are called technical analysis and fundamental analysis and each one is based in radically different principles. In this section we are going to discuss mainly about technical analysis but at the same time we are going to present an introduction about fundamental analysis to explain this approach to visitors.

Fundamental analysis

In the Forex market, fundamental analysis examines in depth the political, social or economic events and how and why these events have historically affected the prices of currencies. So its main purpose is to understand the current state and likely evolution of the pricess according to the socioeconomic circumstances that are currently being developed or in process to be developed.

In the case of stock market analysis for example, the fundamental analysis examines the financial reports published by the company, audit, quarterly and annual balance sheets, market trends, product quality, dividends, sales, position against competitors, news, etc… Ultimately this determines whether the stock price is below, above or match the price at which such share is quoted at the time. If, for example, the result of fundamental analysis shows that the share price should be higher than what is listed at that time, the recommendation is buy it and wait for the market’s true value.

In the case of the Forex market, fundamental analysis studies the economic, political, social and even weather events that can affect the exchange rates of the currencies mainly at long term.

Technical Analysis

Unlike the previous approach, technical analysis is based on the premise that the price of an instrument is inexorably determined by supply and demand. In fact, according to this approach, an instrument like a share or a currency pair for example, is not bought or sold due to its real value, but by what people think it’s worth. Under this premise, all the information required is in the same price of the instrument and its evolution over time. Instead of an extensive analysis of business and economic fundamentals, it would be sufficient to observe the movement of the instrument price. An increase in investor interest in a specific instrument, whatever the reason (in fact no matter what the reason), will result in an increase in the price of such instrument. Part of the work of the Technical Analysis is to determine whether the increase in price will be so significant that worth purchasing that instrument.

In the case of chart patterns analysis, the term Technical Analysis is perhaps not the most appropriate for this type of analysis because it is really based on interpretation of price charts but traditionally is referred to that name. The Art of Technical Analysis is to identify changes in trends in time and to acquire or hold a trade or investment until the trader identify evidence of a change in the trend. Technical Analysis in such “evidence” are identified by a number of indicators and principles such as price patterns, trends, moving averages, stochastic, and many others.

A basic principle of technical analysis is as follows: when a new trend emerge, this trend remains until enough indicators or signals of change appear. Always assume that the trend will remain intact until proven otherwise. Technical analysis does not promise that you can identify the top and bottom of a trend but the area around the top and around the bottom.

The technical analyst uses various methods to analyze the market like the study of the patterns and figures presented in the price charts to determine which is the current trend of a particular instrument or the next market trend change. This approach is known as chartist analysis. They also study various types of technical trend indicators, oscillators, indicators of market volume and others. The most frequently used technical indicators by market analysts are: