Technical analysis is the forecasting of future price movements based on past price movements. Technical analysis is the study of the price behavior in the Forex market, as a representation of underlying demand and supply factors. The technique uses charts and computer programs to study stock trading volume and price movements to identify trends in the market. A decision is made by an investor only after examining the trend and then judging the future trend of the currency pair. Technical analysis only uses publically available Forex prices to make an investment decision. Technical analysis is applicable to stocks, indices, commodities, future or any other tradable instrument, although its application is most popular in the Forex market.
Technical analysis differs from fundamental analysis. Firstly, technical analysis studies market action, or the price or value of a currency whereas fundamental analysis looks at factors affecting demand and the supply behind a currency, say the US Dollar. Secondly, technical analysis looks at the effect of market movement whereas fundamental analysis looks at the cause and the effect of the market movements.
Principles of technical analysis
- Market discount Technical analysis suggests that current price reflects all market information. Market value is determined mainly by supply and demand.
- Price moves in trends The technical analyst believes that profit can be made only from following the market trend.
- History repeats Itself Stock price tends to move in patterns which stay for a long period of time. Also, there are many chart patterns which repeat over and over again.
Technical analysis is done using the following methods:
- Moving Averages This method helps to identify both long and short term Forex trends. There are different kinds of moving averages including simple moving average (SMA), exponential moving average (EMA), etc.
- Charts and patterns Charts and patterns are also used to identify trends in currency price movements, in order to take future trading decisions. Some of the popular patterns are cup and handle, head and shoulders, bump and run etc.
Technical analysis is used by:
- Day traders: A day trader interprets the market for trading within the same day. They are also known as intraday traders.
- Short term investors: This class mainly includes Forex brokers and technical analysts, who trade in a short timeframe; they also tend to make the maximum profits in the Forex market.
- Hedgers: They are basically big investors who have lots of money and hence look to the Forex market to hedge their own risk.
Strengths of Technical analysis:
- Technical analysis can be applied on any financial security including shares, unit trusts, commodities, futures and of course Forex.
- Technical analysts or investors can adapt their investment style to daily, weekly, monthly, intraday, 30 minute chart or even minute to minute charting.
Drawbacks of technical analysis:
- Technical analysis is subject to personal bias and also it can be easily misinterpreted.
- It is based on the assumption that what has happened in the immediate past will continue into the future.
- There are certain indicators, patterns and rules which do not work in technical analysis.
Today the world of technical analysis is huge and there are many patterns and indicators which are followed by investors for successful investment. Technical analysis considers the market to be 80% psychological and 20% logical.
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