Technical Analysis

Technical analysis and fundamental analysisThis chapter and the next one provide insight into the two major methods ofanalysis used to forecast the behavior of the Forex market. Technical analysisand fundamental analysis differ greatly, but both can be useful forecastingtools for the Forex trader. They have the same goal - to predict a price ormovement. The technician studies the effects, while the fundamentaliststudies the causes of market movements. Many successful traders combine amixture of both approaches for superior results.

Technical analysis
Technical analysis is a method of predicting price movements and futuremarket trends by studying what has occurred in the past using charts. Technical analysis is concerned with what has actually happened in themarket, rather than what should happen, and takes into account the price ofinstruments and the volume of trading, and creates charts from that data as aprimary tool. One major advantage of technical analysis is that experiencedanalysts can follow many markets and market instruments simultaneously.

Technical analysis is built on three essential principles:

1. Market action discounts everything! This means that the actual price is areflection of everything that is known to the market that could affect it.Some of these factors are: fundamentals, supply and demand, political factors and market sentiment. However, thepure technical analyst is only concerned with price movements, not with thereasons for any changes.

2. Prices move in trends. Technical analysis is used to identify patterns ofmarket behavior that have long been recognized as significant. For manygiven patterns there is a high probability that they will produce the expectedresults. There are also recognized patterns that repeat themselves on aconsistent basis.

3. History repeats itself. Forex chart patterns have been recognized andcategorized for over 100 years, and the manner in which many patterns arerepeated leads to the conclusion that human psychology changes little overtime. Since patterns have worked well in the past, it is assumed that they willcontinue to work well into the future.

Disadvantages of Technical Analysis
•Some critics claim that the Dow approach (“prices are not random") isquite weak, since today’s prices do not necessarily project futureprices
• The critics claim that signals about the changing of a trend appear toolate, often after the change had already taken place. Therefore,traders who rely on technical analysis react too late, hence losingabout 1/3 of the fluctuations
• Analysis made in short time intervals may be exposed to “noise", andmay result in a misreading of market directions.
• The use of most patterns has been widely publicized in the last severalyears. Many traders are quite familiar with these patterns and often acton them in concern. This creates a self-fulfilling prophecy, as waves ofbuying or selling are created in response to “bullish" or “bearish"patterns.

Advantages of Technical Analysis
• Technical analysis can be used to project movements of any asset available for trade in thecapital market
• Technical analysis focuses on what is happening, as opposed to whathas previously happened, and is therefore valid at any price level
• The technical approach concentrates on prices, which neutralizesexternal factors. Pure technical analysis is based on objective tools(charts, tables) while disregarding emotions and other factors
• Signaling indicators sometimes point to the imminent end of a trend,before it shows in the actual market. Accordingly, the trader canmaintain profit or minimize losses.


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Trading Forex