Speculation, hedging and arbitrage are the three key factors that dominate and influence Forex trading. While every trader may have one of these reasons to play with currencies, the technical analysis helps to forecast the price movements of these currencies. Many technical analysis tools are used to arrive at judgmental trading decisions. Forex market is a round the clock market and therefore the analysis should capture the very minute price movements.
The historical data serves as a strong base for such analysis. The oldest technical analysis tool, known as “candlestick”, is believed to hail from Japan since the 18th Century. Then came the very popular “Dow Theory” in the 19th century, laid down by the very famous Dow Jones.
Any technical analysis would be based upon three assumptions viz.,
- A price trend always has a reason
- Historical trends may repeat
- All considerations in the analysis are based on the current market trend.
A good technical analysis is based on different trend patterns designed by the technical analysts. A best technical analyst would always advice to go along with the current trend, that is a trader should “Go Long or Hold” in an upside trend and “Go Short or Sell” in a downside trend. Technical analysis is all about charting out different patterns so as to enable the trader to decide on the best pattern and follow the same in his trading decision. The popular technical analysis tools are charts, trend patterns and technical indicators.
Technical analysts use the historical trends and market analysis to correlate it with the current factors affecting the market. This helps to understand the price direction in the future. Hence technical analysis involves much of mathematical calculations and statistical analysis. A number of technical analysis indicators have been widely used, again as per the perceptions and beliefs of the traders. Political, social, psychological and economic events largely affect the technical analysis. A good reason why technical analysis has gained much significance than any other analysis is its ability to gauge the very smallest movements in the market trends.
Technical analysis indicators are many and are based on different ways of analysis. They are based on moving averages, volumes, volatility and range. Moving average based indicators include three types – Moving Average, Moving Average Envelope and Moving Average Convergence Divergence. The volume-based indicators are again classified into Volume, On Balance Volume, Chaikin Money Flow indicator and Accumulation/Distribution. The famous “Bollinger Bands” & “Fibonacci Retracement” are based on volatility analysis. Relative Strength Index and Stochastic method are based on range.
Why Technical Analysis?
While we have explained in brief about technical analysis, you would be keen to know why technical analysis serves as a popular tool in Forex trading. Large hedge funds, financial institutions, banks, corporates dominate Forex market. While they have the state-of-the-art technology to keep an eye on the market movements, they still adapt technical analysis to ensure that all political, social, psychological and economic factors are considered while analyzing the future price movements. Technical analysis is the best tool to identify right trends with correct prices.