Technical analysis is one of the most widely used and popular methods employed by forex traders for interpreting market movements & price trends, recognising profitable opportunities and making informed decisions. It enables an investor to enter or exit a market position at the appropriate moment. It is premised on the basic tenet that historical price trends are an indicator of future price tendencies and movements. Thus, according to this method price is the barometer for all market data and changes thereby. Since forex is an ongoing market there is always a deluge of data available to reckon future price activity. Thus, a multitude of traders refer to charts, tools and indicators before setting out to trade. As human behaviour behind rate changes is invariable, patterns repeat themselves and technical analysts predict future decisions to buy/sell an instrument based on those models.
There are three axioms on which technical analysis is postulated:
1) Market activity discounts all:
Traders use technical analysis mainly because all criteria that impact the market rates-political, economic, social and psychological are included and manifested in the current market price.
2) Prices reflect market direction:
Markets are always on an uptrend, downtrend or move sideways and remain range-bound. Indicators reflect where prices have gone in the past, which gives us an idea about whither they are likely to go next. Generally, the major currency pairs EUR/USD, USD/JPY, USD/CHF and GBP/USD have shown more inclination towards trends while the currency crosses (currency pairs sans the USD) have manifested a greater likelihood of being range-bound.
3) History is repetitive:
If a price level has been held as an important support or resistance in the past traders will base their future trades around that. Technical analysts watch out for repetitive patterns and believe that prices will behave similarly as they did before.
Some of the undeniable advantages of applying technical analysis for earning good returns can be summarized as follows:
In currency trading timing is everything. Through technical analysis traders can easily ascertain the appropriate time to get into or get out of the market. Chart patterns, candlesticks, moving averages, Elliot wave analysis are extremely helpful to make entry and exit points.
Gauging market sentiment:
Technical analysis sends out timely signals about market patterns & investor sentiment and gauges the movements of market makers through price-volume analysis. It also forewarns about trend reversals.
Fast and cheap:
In currency trading technical analysis is relatively cheaper, easy-to-use as compared to other methods like Fundamental analysis. Also, there are a number of brokerage firms that offer investors with free charts and technical data.
Technical analysis is suitable for short term trades, swing traders, and long-term investments too. Technical charts provide a wealth of information that enables investors to strategize and excel. Support and resistance levels, chart patterns, market volatility, and trader’s sentiment are all provided by technical analysis.
Some of the most commonly used technical analysis tools are:
It is a highly popular technical analysis tool that reckons the volatility of a currency pair. It consists of a moving average along with upper and lower bands that specify pricing channels.
In technical analysis Fibonacci retracement is used to recognise crucial support/resistance levels. The most frequently used Fibonacci levels are 23.6%, 38.2%, 50%, 61.8% and 100%.
The moving average (MA) is computed by taking out the average of a series of past price data. Once calculated it is plotted onto a chart with smoothed data rather than everyday price undulations. The average can be determined for a definite period of time like 20 days, 40 minutes,50 weeks or any stipulated time period.
Moving average convergence divergence (MACD):
Moving average convergence divergence (MACD) is a very useful indicator that follows trends and displays the relationship between two moving averages of prices. It enables traders to easily recognise the short-term trend direction. The MACD is calculated by deducting the 26-day exponential moving average (EMA) from the 12-day EMA.
The stochastic oscillator is a popularly used momentum indicator that was first used in the late 1950s by George Lane. It typically compares the ending price of an instrument to the range of its prices over a certain period of time, usually a 14-day period.
It's a truism as most investors will agree that there is no certitude as far as decoding market fluctuations is concerned. Thus, success in your trades does not involve being correct or incorrect. It implies anticipating potential market sentiments and taking the right decision at the apt time. There is no miraculous combination of technical indicators or a winning strategy that can guarantee you success in your trades. Successful trading is all about proper risk management i.e. carefully assessing your risk-to-reward ratio, trading discipline and curbing your emotions.