Using Technical Analysis In The Currency Market
See the Popular Charting Tools Used by Forex Technical Analysts
Technical analysis is probably the most popular form of financial market analysis, since it can be applied to literally any market from currencies to stocks to commodities. It has to do with examining charts, price data, and using different mathematical indicators to try and come up with accurate trading signals.
The different technical methods that this article will cover are support and resistance, fibonacci retracements and profit targets, momentum oscillators such as the Relative Strength Index (RSI), and moving averages. While this is by no means a comprehensive guide to forex technical analysis, it will introduce you to some of the most popular trading tools and allow you to acquaint yourself with the notion of analyzing price charts.
In a sentence, technical analysis is the study of historical price movements to try and predict future results. While this is not always 100% accurate, it is based on the simple premise that all market movements are caused by real people, and human psychology and investment behavior tend to remain consistent. And because technical analysis is widely practiced by so many traders, with many of them even following the exact same indicators such as support and resistance lines, there is an element of self-fulfillment involved.
Support and resistance lines are horizontal lines that are drawn on a price chart to signify price levels that many traders deem to be significant. These lines can be identified by using trendlines or based on prior price action such as highs and lows, and the strongest trendlines tend to be based on whole numbers (i.e. EUR/USD 1.1900). A key trait of support and resistance lines is that once a key line is broken, it will switch direction. So if there was a large amount of selling and a support line was broken, it would then act as a resistance line as the market again approached this level.
Fibbonacci levels are based upon the famed Fibonacci sequence of numbers that tend to appear in natural systems. When this sequence of numbers is analyzed, two of the main ratios that appear are 38.2% and 61.8% (although 50% is not strictly a Fibonacci ratio, many trading systems will use this level also). There are two main ways in which a forex trader can apply Fibonacci ratios: retracements, which are used to locate entry points; and profit targets, which are used to locate exit points.
Another popular tool that is widely used are moving averages. The two most popular moving averages are the Simple Moving Average and the Exponential Moving Average: the SMA gives equal weight to each price point, and the EMA gives more weight to recent price data. The way that most traders use moving averages are for buy and sell signals that are generated when moving averages of different time frames intersect, or when the moving average intersects with the price data itself. Using a short-term and a long-term moving average in conjunction with each other can be a good way to locate trading signals, and this is the basic principle that the Moving Average Convergence-Divergence (MACD) indicator is founded upon.
A momentum indicator determines the speed at which prices are moving, and with this data a trader can determine whether a trend is likely to continue or whether it looks like it may reverse. A popular way to use momentum indicators and oscillators is to identify whether the market looks overbought or oversold, which describes how quickly prices have been changing relative to privious price data. With this information, a forex trader has a better probability of predicting in advance which trading signals will be strongest and which are not so strong, based on their direction.
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