Introduction to Technical Analysis
When it comes to trading in the Forex market, there are two main schools of thought as to when, what and how to trade – Technical and Fundamental Analysis. (Refer to Fundamental Analysis)
The following is a brief guide to Technical analysis which is the study of historical and current market data (including price, interest rates, volumes and volatility) all for the purpose of forecasting future market activity. The most common form of technical analysis is based on historical and current price activity.
Technical analysis is based on the idea that past results impacts and determines future results, and using this analysis correctly will give a trader an edge to successful trading. By definition the more people that use technical analysis as a guide to trading in a particular market, the more technical analysis becomes relevant. The Forex market is the market where technical analysis is most widely used; in a way it becomes a self fulfilling prophesy.
In order to make the data easier to read and analyzed, the past market data is saved and brought up in a form of a chart; data is produced in charts over different time frames from tick charts through to monthly or even yearly charts. The analyst study’s the periodical charts over a length of time trying to find patterns or signals that will affectively indicate appropriate entry and exit levels of a future or existing trade. Studying the data via a chart allows the analyst a quick view of the data in a comfortable format that will hopefully represent the future direction of the instrument studied; in a word they are looking for trends.
As stated earlier fundamentalists and technical analysts have a constant argument over which theory of analysis will give the best results over time. The basic argument by technical analysts in regards to fundamental data is that the results of past fundamental releases and the expectations of future results are already built into the current market price. Therefore apart form unsuspected world events such as natural disasters, government intervention, and unsuspected results and releases the current price shows the market’s expected value taking all the known information into consideration.
As a summary there are three main points that are assumed for technical analysis:
- History repeats itself – past events dictate future events,
- The current price is the markets view of all known information including all fundamentals in past and expected future events,
- Charts can depict the trend status of an instrument,
- Whether the instrument is in an upward or downward trend or whether it is range bound (sideways).
The whole point of technical analysis can be summarized into two points:
- Identify the status of the instrument and what kind of trend it is in currently;
- Identify entry and exit points.
Indicators – introduction
Over time technical indicators were added to assist the analyst in his attempt to define the trend of an instrument. These indicators are mathematical manipulations that occur on a real time basis against the saved historical and current data. These technical indicators are used in conjunction with the periodic charts and other indicators for the soul purpose of identifying the trend as well as entry and exit points.
The most important element in the study of technical analysis is sticking to the rules that you set yourself as an analyst and not to let the market dictate changes. If your studies showed that something was to occur, then follow your original line of thought; if you were wrong and the market behaved differently then exit the trade and examine your analysis. First check to see if you followed your rules, if you didn’t ask yourself why and work on your discipline; if you did, find out what went wrong and check to see if your rules need to be adjusted – test them over time. Whatever you do as an analyst, the most important thing to remember is to stick to your game plan.
Charts – Periods
Most trading platforms today offer a charting facility as part of the platform; as stated above charts can be viewed in many periods from the tick (a tick is a single quote) periods to monthly and sometimes even yearly periods.
Charts are represent sequential periods of historical prices. As can be imagined the fastest moving chart is the simple tick chart. The tick chart is the only chart that can be viewed in a line format only, since the single tick encompasses the entire period.
As can be deduced from the above, the longer the period the slower the chart; longer period charts tend to show more stable trends while the shorter period charts tend to be used to pick entry and exit points.
Because of this technical analysts often analyze the same instrument under two or more time periods to see if their decision on the trend of the instrument is supported by more than one period, this gives the analyst greater confidence in his decision of entry and exit points.
Charts – Types
There are several types of charts that are used, the three most common are, line, bar and candle charts, the following is a brief description of each:
- Line charts are the most basic of all the charts and as such offer the least detail. The line chart simply displays a link of the last tick of each period and joins them as a continuous line.
- Bar charts offer greater detail then a regular line chart. Each period of time in a bar chart is indicated by a bar for that period. Within the bar an analyst is able to see not only the general movement across the periods but also within the periods itself. The analyst is able to view the highest and lowest tick in the period as well as the opening and closing tick within the period.
- Candlestick charts. The candlestick chart is a color coded bar chart. The details offered on both charts are the same. The candlestick has gained popularity because the information contained is more easily seen then in that of the bar chart. The candlestick is made up of a body and two wicks sticking out of either end of the candle. The top of the wick represents the high tick or quote of that period while the bottom of the wick represents the lowest tick or quote of the period. The body is typically colored in red or green/blue depending if the period ended higher or lower then its predecessor. If the body is filled in red this is an indication that the period closed lower then its predecessor. The top of the candle is the opening tick and the bottom of the candle indicates the closing tick of the period. Conversely if the candle is colored in green or blue then the top of the candle represents the closing tick of the period while the bottom of the candle represents the opening tick.
