Basics of Technical Analysis
There are two reasons why traders are taking a position on the currency market: fundamental and technical ones. Both are equally important in the decision-making process. It is common among traders to consider both analyses before engaging in a trade, especially if the time horizon for that trade is consistent. There are advantages and disadvantages in using these two analysis types separately, and to better manage them, they need to be considered together. A currency pair is formed out of two currencies that are paired against each other. If one is looking at the differences between the two economies that represent these two currencies and compares them, then one economy will turn out doing better than the other one. This should reflect in its currency being stronger than the currency against it is paired in a currency pair. The process of comparing economic data to gather information about how a currency or a currency pair is moving is called fundamental analysis. Traders using fundamental analysis as the basis for their decisions are being called fundamental traders. The ones that fit in this category are usually having a longer time perspective for a trade to reach a target than technical traders.
What is Technical Analysis
Technical traders are chart people. These people are looking at chart setups on different timeframes and from different angles and compare historical data to find out future price levels. Patterns have the tendency to repeat themselves in time as history repeats itself. This is technical analysis and much more.
Technical Analysis Based on Indicators
Technical traders are of different types as well, and most of them are using indicators to get in and out of a trade. The idea behind this type of trading is to look at overbought and oversold levels in an oscillator or to use a trend indicator to ride a trend. The technical analysis field is so vast as there are so many indicators that it is impossible to consider them all. Therefore, everyone is using what fits with their personality and trading style. Trading is much about market psychology and people’s view of the market. Not everyone can be a trader as well as not everyone trades with the same time horizon in mind. A good example would be that traders are finding it equally difficult to hold a winning position for a long time or to hold a losing one for the same period. In the first instance, the fear of market returning and wiping out profits dominates and in the second, the fear of taking the loss only to watch market returning to your initial direction will punish traders. To avoid emotions, traders that fit into this category are using technical indicators, trend or oscillators, and rely on the signals provided. This works to some extent, but even in this case, human nature plays tricks on us and rules are not followed one hundred percent of the time.
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Technical Analysis Based on Technical Trading Strategies
The technical analysis field is an old one, and the whole thing started in the United States. This is also known as the Western approach to technical analysis, and at the beginning, it was dealing with basic patterns popular even today. Such patterns are head and shoulders, wedges, pennants, flags, triangles, etc., things that are mandatory to be known even today by all traders involved in speculation. However, things evolved and technical analysis grew with more and more concepts.
Elliott Waves Theory
This is one of the most popular theories and all traders in the world know at least some basic stuff regarding it. The reason why it is so popular comes from the fact that the concept is an easy one to be understood. However, like it is with all things that are simple or perceived to be simple, there is a catch. Elliott Waves theory is one of the most complicated and diversified trading theories in the world, and the only one that allows putting a time perspective to a trade.
Japanese Candlestick Techniques
In contrast with the Western approach, Japanese dealt with candlesticks throughout their history, as this was a new method to forecast fish prices. Candlesticks were embraced with enthusiasm in the Western world as they are powerful patterns. The beauty of candlesticks comes from the fact that they are reversal patterns, and the bigger the time frame is, the stronger and more powerful the reversal to follow. They give clear entry and exit levels and allow for proper risk-reward ratios to be defined.
Other Trading Theories
The above-mentioned trading theories are not the only ones that exist. There are traders that look at Gann, Pitchfork, DeMark, Gartley, approaches, or use Point and Figure and Renko charts to forecast a trend. All these theories are coming with their specific rules and interpretations but in the end, the aim is the same: the forecast future prices based on something that happened in the past. There is not a clear recipe or a holy grail for which theory is the best. If it was, then trading or speculation would not be so challenging. There are people that made it, in the sense that they found something that works for their trading style and life and, together with a sound money management system and trading discipline they can monetize the whole system. There are simply people that are not done for trading as emotions and the day to day roller-coaster in the currency markets are too much to handle. In any case, one thing is sure: technical analysis is here to stay but it won’t work as a stand-alone way of looking at things. It is no wonder that retail traders are fond of technical analysis like trading with indicators and are relying their trading decision on these indicators. In doing that, they’re having short time horizons for their trades and they are mostly scalpers (traders that keep a position open for a short period and have multiple entries and exits during a trading day). Scalping is a great way of profiting from the swings in the Forex market but unfortunately, it is not for anyone. The high-frequency trading industry is having its footprint on it and the swings caused by trading robots are enough to wipe out even the most experienced swing traders. Experience is key here but to gain experience one needs to survive first in this ever-changing environment. To gain experience it means other factors rather than only technical ones need to be considered. Fundamental factors are the ones that come to complement the overall picture and by the time experience is gained, traders are hooked on the fundamental side as well. And just like that, both fundamental and technical analysis end up being the reason for taking a trade in the Forex market. This is the right approach and anyone failing to understand this will suffer when it comes to the profitability of their trading account.
Recommended Further Readings
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
- What Makes a Good Forex Broker?
– Things to consider when deciding what broker to trade with. What are the factors that weigh the most in the decision-making process?
- Why Trading with a Regulated Forex Broker?
– What is regulation for a brokerage house, why it is important, things to look for, how to check if the broker is telling the truth, etc.
- Benefits of Mobile Forex Trading
– Pros and Cons of mobile trading, highlighting the net benefits of it.
- Explaining Commissions in Forex Trading
– What type of Forex trading accounts are subject to paying commissions, what does it means and is this a good or a bad thing?
- Designing a neural network for forecasting financial and economic time series. Kaastra, I., & Boyd, M. (1996). Neurocomputing, 10(3), 215-236.
- Beyond technical analysis: How to develop and implement a winning trading system. Chande TS. John Wiley & Sons; 2001 May 24.