What is Forex Technical Analysis
Forex market technical analysis is a method of evaluating trading instruments by analysing the statistical record of their price history. Technical analysis is not concerned with 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, and is of utmost importance to 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 combination with other methods.
Technical analysis is statistical in nature, because the data it analyses can be easily quantified and further visually demonstrated through charts and chart overlays. In Forex we look at currency pairs using five basic units of historical data: the opening price, the highest price, the lowest price and the 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.
FX technical analysis has existed for as long as there have been markets driven by supply and demand. The first known historical records are dated around the 17th century for Dutch merchants, and the 18th century for Japanese rice traders. At the end of the 19th century technical analysis began to take off, as it was propelled into the trading masses by the founder and editor of The Wall Street Journal, Charles Dow.
Among his contemporary compatriots were other technical pioneers; Ralph Nelson Elliott – the founder of the famous Elliott wave theory, William Delbert Gann – the founder of the Gann angles theory and Richard Demille Wyckoff. Wyckoff was possibly the first market psychologist who theorised that the market with all the historical data recorded is best considered as a single mind.
His teachings are still taught at some of the top universities in the US. For most of the 20th century and throughout history, technical analysis was limited to charting, as statistical computation of vast amounts of data was unavailable. That means no indicators. It also means that now – the digital era – can probably be considered as the Golden Age of technical analysis.
Although Forex technical analysis typically employs numerous tools, techniques and methods, it is generally chart bound. Traders use charts, which are nothing more than 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 latest, in order to figure out how to plan their technical trades. 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 then end with a multitude of technical indicators which are applied directly to their charts in real time.
Does Technical Analysis Help?
Some people believe that looking at historical price data will not provide any value for current decisions. They may believe that the random walk theory (or efficient-market hypothesis) is true, which states that financial market prices move and behave according to a random walk (whereby price changes are random) and thus cannot be predicted.
Many investors, however, heavily dispute this theory, including famous investor Warren Buffett, who commented that he is “convinced that there is much inefficiency in the market”. Inefficiencies, in turn, create potential opportunities for traders to capitalise on price movements. They believe that analysing price action, in fact, enables traders to make better, more informed trading decisions.
How and Why Does Technical Analysis Help?
The financial markets are not simple to analyse. They are impacted and influenced by a wide range of factors including, for instance, monetary policies administered by central banks, fiscal policies delivered by governments, and many internal economic factors that are determined by companies and consumers alike. Studying all those factors, realising how they impact all of the assets and markets, and knowing which factors have the most impact is an incredibly difficult task.
Equally important, is that when analysing these factors, it is easy to see that traders can make errors in cause and effect. This is particularly true for individual traders who have limited time and focus. However, the good news is that there is a reliable short-cut whereby analysts can focus a lot of their attention on just one piece of data – price movement. Technical analysis (TA) is also known as chart analysis. TA allows traders to analyse historical price movement.
This analysis can then offer traders:
- A way how to judge whether the chart is interesting to trade on or not
- How traders can look for potential trade setup
- Where traders can find potential trade setups
- How to manage those potential trade setups
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