Welcome to my introduction to technical analysis, where I will be covering the basic idea behind technical analysis and how you can use to make trading decisions based on past price movements. Before we get into the “meat” of technical analysis, there are a few underlying assumptions about the markets that form the basis of TA.
Firstly, the users of technical analysis believe that the current market price reflects all relevant information about the currency pair under consideration at all times. In other words, everything you need to know about the pair is there on the price chart. Users of technical analysis also believe that there are repeatable price patterns observed in the past that will happen again in the future. In other words, history repeats itself because market participants will react similarly when certain market conditions are in place.
3 Keys to Technical Analysis Explained:
The following video explains the 3 typs of technical analysis: chart analysis, pattern recognition, and momentum and trend analysis.
The Basic Pattern Of Technical Analysis
Now that you understand the underlying assumptions behind the practice of technical analysis, here’s the bottom line. People who use technical analysis do so because they believe that the recognition of patterns and how they tend to play out will give them a discernible edge in their trading. Therefore, if you choose to utilize technical analysis as a tool in your own trading decision making process, then it would be wise to learn some of the basic patterns of TA.
One of the most common recurring patterns is that of the trend. If you’ve been trading for any length of time, you will have heard the saying “the trend is your friend”. Well, that’s only true if you’re trading in the direction of the trend of course! Regardless of what some critics may say, prices do move in observable trends, although the problem most traders have is that they never know when the trend will continue, and when the trend will end.
The definition of a trend is the general direction or bias that the market prices have to move in one particular direction. For example, if the prices of the EUR/USD are consistently going up over time, then you could say that there’s an uptrend in place, and vice versa. From a more purists’ point of view, a clearer definition of an uptrend would be that the prices consistently make “higher highs” and “higher lows”.
Typically, a technical analyst would use a simple tool called a trendline to discern whether a trend is in a “continuation” mode. To use this technique, you simply connect three or more established low points with a straight line in an uptrend to establish the trendline, and three or more established high points in a downtrend. When the price extends beyond the trendline, the trend is said to be “broken”, signaling an impending reversal.
Support, Resistance And Price Channels
As you would imagine, prices don’t move in uptrends or downtrends all of the time. In fact, estimates put prolonged trends to make up just 10-30% of all market movements. The rest of the time, the prices are said to be in “non trending” mode, which means that the prices are generally not going anywhere fast. During this “non trending” mode, prices will tend to bounce between two extremes, which are called “support” and “resistance”, with Support being the lower limit that behaves as a floor to the price and Resistance being the upper limit that acts as the ceiling. Identifying potential support and resistance points are another key skill in the practice of technical analysis. Common S/R levels in the currency trading arena are the round numbers, and what are called “Fibonacci levels” which are beyond the scope of this article.
When it comes to technical analysis, trendlines and support/resistance lines are just the tip of the iceberg. There are numerous TA tools and indicators that will allow you to analyze the past behavior of the market prices to make an informed trading decision, including moving averages and oscillators just to name a few. Most importantly, remember that technical analysis is only a tool that has proven to work well for many people in the past, so long as you use it together with sound risk management and emotional control.