In Forex, as well as in many other financial markets, technical analysis is a method of price forecasting for financial assets. In Forex we look at currency pairs using five basic units of historical data: the opening price, the highest price, the lowest price and closing price. The fifth dimension is represented by the volume, but this can be problematic in the Forex spot market,
since it can’t quite be measured in the same way as it is with stocks, commodities and even Forex futures. Fundamental analysis is statistical in nature, because the data it analyses can be easily quantified and further visually demonstrated through charts and chart overlays.
Although Forex technical analysis employs numerous tools, techniques and methods, it is generally chart bound. Traders use charts, which are nothing more than a price history depicted graphically which ease the search for price patterns. Price patterns, whether they are trend patterns, reversal patterns or ranging patterns, are market formations – commonly referred to as market moods – that increase the probability of winning trades. For many technical traders, the trick is in figuring out what the current mood of the market is and how long is it going to last.
To help identify these major patterns, traders have developed and perfected a series of charting tools. They start with support and resistance lines and price channels and end with a multitude of technical indicators which are applied directly to their charts in real time.
Technical indicators are statistically programmed add-ons to the body of trading platforms that mathematically analyse relations between various elements in an attempt to assist with price prediction. Broadly speaking, there are four groups of technical indicators. The most popular ones are:
Trend indicators: moving average (MA), directional moving average (ADX), Ichimoku Kinko Hyo, moving average convergence/divergence (MACD), Parabolic SAR Indicator
Momentum: relative strength index (RSI), stochastic oscillator, Williams % range (%R)
Volatility: average true range (ATR), bollinger bands (BB), standard deviation
Volume: money flow index, accumulation/distribution line, on-balance volume
The last group should be mentioned specifically, due to trading volume being its primary source of data for analysis.
It is undoubtedly true that studies of total traded volume are at least helpful to financial traders in the stock market, the futures market and the commodity market amongst others. Although the overall theories of these studies can apply to the Forex spot market as well, there is simply no way to analyse Forex spot total traded volume.
It’s important to note that because the Forex spot market is traded OTC, no total volume can be calculated. This means that all the indicators of volume a trader sees on his platform only use a sample of total volume for analysis. How much of the data is representative, if at all, is a question for another article.
Technical analysis is widely used by financial traders around the world, however it is a method that is mostly favoured by Forex traders due to the possibility of their application on time frames that are lower than one day. That being said, many scholars disregard the concept of technical analysis in Forex or any other market, claiming that it is utterly incapable of any price prediction. Users of the FX trading technical analysis believe that even though it’s incapable of predicting the future, technical analysis is still a powerful tool for analysing the present, which is all they really need to be consistently profitable.
Three Principles of Technical Analysis :
- Price action discounts everything
- Price moves in trends
- History repeats itself
Forex market technical analysis is a method of evaluating trading instruments by analysing the statistical record of their price history. Technical analysis couldn’t care less about the factors that influence bulls and bears, supply and demand, or any other factors that may affect prices. By analysing only what has already happened can technical traders gain their competitive edge.
Most often the price history is committed to charts by the means of various charting methods, with Japanese candlesticks being one such method. Various tools such as support and resistance lines, trend lines, and technical indicators, are used to analyse charts in an attempt to identify patterns.
Patterns are the key concept in technical Forex analysis that everything revolves around. The existence of market trends is an empirically proven fact very dear to the heart of every technical trader.
Despite daily Forex technical analysis being criticised in some academic circles for its insolvency, most practical traders from various financial markets apply at least some form of it, usually in a combination with other methods.