This Article will outline the technical analysis and fundamental analysis used by professional forex traders to identify patterns in forex, and land huge profits in forex trading. This Article provides insight into the two major methods of analysis used to forecast the behavior of the forex market.
Technical analysis and fundamental analysis differ greatly, but both can be useful forecasting tools for you (the forex trader) in tracking and identifying Forex Trading Patterns. They have the same goal - to predict a price or movement. The technician studies the effects, while the fundamentalist studies the cause of the forex market movements. Many successful traders combine a mixture of both approaches for superior results by using Forex Chart Patterns.
Note: If both fundamental analysis and technical analysis point to the same direction, your chances for profitable trading are much better.
So let us begin with the technical analysis:
Technical analysis is a method of predicting price movements and future market trends by studying what has occurred in the past using charts (discussed in another article). Technical analysis is concerned with what has actually happened in the market, rather than what should happen, and takes into account the price of instruments and volume of trading, and creates charts from that data as a primary tool for forecasting forex trading movement. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments simultaneously.
Technical analysis is built on three essential principles
- Market action discounts everything: This means that the actual price is dictated by everything that is known to the market that could affect it. Some of these factors are fundamentals (inflation, interest rates, etc.), supply and demand, political factors (yes even the upcoming elections can be a factor) and market sentiment. But, the pure technical analysis is only concerned with price movements, not with the reasons for any change. - Prices move in trends, and these trends become easily identified with the use of Forex Trading Patterns: Technical analysis is used to identify patterns of market behavior that have long been recognized as significant. For many given patterns, there is a high probability that they will produce the expected results.
There are also recognized patterns that repeat themselves on a consistent basis. - History repeats itself: Forex chart patterns have been recognized and categorized for over 100 years, and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little over time. Since patterns have worked well in the past, it is assumed that they will continue to work well into the future.
Disadvantages of technical analysis
- Some critic claim that the Dow approach ("prices are not random") is quite weak, since today's prices do not necessarily project future prices;
- The critics claim that signals about the changing of trends appear too late, often after the change had already taken place. Therefore, traders who rely on technical analysis react to late, hence losing about 1/3 of the fluctuation (thus another reason for the use of Forex Trading Patterns);
- Analysis made in short time intervals may be exposed to "noise", and may result in a misreading of market directions;
- The use of most forex patterns has been widely publicized in the last several years. Many traders are quite familiar with these patterns and often act on them in concern. This creates a self-fulfilling prophecy, as waves of buying or selling are created in response to "bullish" or "bearish" patterns.
Advantages of Technical Analysis
- Technical analysis can be used to project movements of any asset (which is priced under demand/supply forces) available for trade in the capital market;
- Technical analysis focuses on what is happening, as opposed to what has happened, and is therefore valid at any price level;
- The technical approach concentrates on prices, which neutralizes external factors. Pure technical analysis is based on objective tools (charts, tables) while disregarding emotions and other factors;
- Signaling indicators sometimes point to the imminent end of a trend, maintain profit or minimize losses.
Various techniques and terms you will want to know
Many different techniques and indicators can be used to follow and predict trends in forex markets. The objective is to predict the major components of the trend: its direction, its level and the timing. Some of the most widely known include:
- Bollinger Bands - a range of price volatility named after John Bollinger, who invented them in the 1980s. They evolved from the concept of trading bands, and can be used to measure the relative height or depth of price.
A band is plotted two standards deviations away from a simple moving average. As standard deviation is measured of volatility, Bollinger Bands adjust themselves to market conditions. When the market becomes more volatile, the bands widen (move further away from the average), and during less volatile periods, the bands contract (move closer to the average).
Ballinger Bands are one of the most popular technical analysis techniques used by forex traders. The closer the prices move to the upper band, the more overbought is the market, and the closer prices move to the lower band, the more oversold is the market.
- Support / Resistance – The Support level is the lowest price an instrument trades at over a period of time. The longer the price stays at a particular level, the stronger the support at that level. On the chart this is price level under the market where buying interest is sufficiently strong to overcome selling pressure. Some traders believe that the stronger the support at a given level, the less likely it will break below that level in the future. The Resistance level is a price at which an instrument or market can trade, but which it cannot exceed, for a certain period of time. On the chart this is a price level over the market where selling pressure overcomes buying pressure, and a price advance is turned back.
- Support / Resistance Breakout – When a price passes through and stays beyond an area of support or resistance.
- CCI Commodity Channel Index – An oscillator used to help determine when an investment instrument has been overbought and oversold. The Commodity Channel Index, first developed by Donald Lambert, quantifies the relationship between the asset’s price, a moving average (MA) of the asset’s price, and normal deviations (D) from that average. The CCI has seen substantial growth in popularity amongst technical investors; today’s trader often use the indicator to determine cyclical trends in equities and currencies as well as commodities.
The CCI, when used in conjunction with other oscillators, can be a valuable tool to identify potential peaks and valleys in the asset’s price, and thus provide investors with reasonable evidence to estimate changes in the direction of price movement of the asset.
- Hikkake Pattern – A method of identifying reversals and continuation patterns. Used for determining marker turning-points and continuations (also known as trend behavior). It is a simple pattern that can be viewed in market price data, using traditional bar charts, or Japanese candlestick charts. There will be more on this topic in Forex Patterns and Forecast Methods Used Today For Successful Forex Trading! Part 2but for now keep in mind that the easiest way to stay ahead of the curve in forex trading is by simply tracking and identifying patterns in fores trading.
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