An Introduction to Technical Analysis

Technical analysis has been a popular form of analysis in traditional investing, but it can be used to help lock in profits in Forex trading. Technical analysis looks at past prices to try and predict the future. There are several methods traders can use, but they all use past price movements. Here, we will look at how to use technical analysis when trading Forex.

Technical vs. Fundamental Analysis

Technical analysis is the study of charts and indicators to try and predict future prices. Fundamental analysis is the study of economic data and reports to understand how the currency market will respond. Some traders use only technical analysis, others both technical and fundamental analysis. Neither is completely perfect. As your trading skills develop, you might start to develop a preference for one or the other.

Benefits of Technical Analysis

Technical analysis offers several benefits to Forex traders:

Emphasis on Prices

Unlike fundamental analysis, technical analysis is concerned about the movement of prices. Charts will show you how prices are moving, trending, and the strength of those trends. Indicators such as volume, oscillators and momentum complete the big picture. You can look at all this information on your screen.

Easy to Spot Trends

Trends are easily spotted with technical analysis. A moving average line can quickly tell you if a price is trending or if it is stuck in a rut. Trends are important because a currency is likely to continue moving in the direction of the trend. Only a chart can spot one.

Easy to Spot Patterns

Traders can use charts to help spot patterns and act on them. Only technical analysis can help you do this.

Inexpensive

You can get access to charts and technical indicators for free or at a low cost thanks to the Internet. Many brokers offer technical analysis services as part of a package to their clients.

A Wealth of Information

Only charts give traders the big picture about a currency. There are over fifty kinds of indicators to help you predict prices and these can only be shown with charts. Charts can go much deeper and show you how long are trend has been developing for, and whether there are patterns you can profit from.

Downsides to Technical Analysis

There are several downsides to technical analysis:

World Events

Natural disasters, war, acts of terrorism and other similar events can move currencies contrary to what a technical forecast might tell you.

Economic Data

Economic data such as unemployment figures can move currencies. Bear these in mind even when trading with technical analysis.

Lots of Indicators

It is easy to be overwhelmed with technical analysis. There are lots of indicators and it can be hard for new traders to get started.

What Do Charts Tell You?

Charts can tell traders a wealth of information about the price movement of a currency pair. Using technical indicators can help deduce the future movement upwards or downwards.

What to Look for?

There are two key lines traders look for to indicate where and how the currency is likely to move — the support and resistance lines. Prices tend to bounce between these two lines and head towards one or the other.

Support Line

The support line can be found below the currency pair price. It is the price level at which demand is thought to be strong enough to prevent the currency price from declining further. As the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell.

Resistance Line

The resistance line can be found above the currency pair price. It is the price level which is strong enough to prevent the currency price from rising further.

Trend Lines

Look out for trend lines. They show how a currency price is moving — up, down, or sideways — and are helpful when trying to predict future prices. Rising peaks and troughs indicate an upwards trend, while falling falling peaks and troughs indicate a downwards trend. Trends can last longer than a year (major), one to six months (intermediate) or less than a month (minor).

Technical Indicators

Technical indicators study a particular aspect of a currency. There are over 50 which can be used, so do not worry about knowing all of them to begin with. Here are a couple for you to think about when trading:

Relative Strength Index (RSI)

The RSI measures the ratio of up-moves to down-moves, expressing the index in a range from 0 — 100. An RSI of 70 or higher indicates that the currency has been overbought (and is likely to fall). An RSI of 30 or less indicates that the currency has been oversold (and may rise).

Moving Averages

Moving averages are useful because they confirm trends. The price is averaged over a number of days. The oldest price is dropped out of the average each day and is replaced by the current price.

Conclusion

Use the technical analysis provided by your broker and paper trade first to understand the basics of charting. Enjoy this exciting way of trading and have fun.

Guest post contributed on behalf of Sunbird FX – home to the MetaTrader 5 Forex trading platform.