What is Technical Analysis in Forex?

Technical Analysis in Forex is one of the most crucial frames which a trader needs to be accustomed to in Forex. But what is it exactly? Well, the theory is that a person can look at the historical data of price movements and try to determine the current trading conditions and potential movement in prices. This is actually the work of a technical analyst. As a trader, if you make use of technical analysis, you are known as a technical trader.

In theory, all the present market information is reflected in the price. Hence, technical analysis is pretty imperative for a trader. All known fundamental information is priced into the present market price. If this is really true, what more do you need to make a trade?

Technical analysis can look at the rhythm, progress, flow and trends in the action of the price. Keeping in mind the fact that, ‘history repeats itself’, you can concentrate on technical analysis to maximize your profits in Forex and minimize losses or associated risks.

If history depicts that a certain price has been acting as a major support or resistance level in the past, as a forex trader, you can keep an eye out for it and base all your trades in that historical level of price. In technical analysis, you will need to look for similar patterns which have developed in the past and you will be able to ideate about how the price is expected to act in the present and the future of your trade.

One important thing to remember is that, technical analysis is not about prediction. It is more of a probability. It is the study of historical price action which identifies patterns to help determine the probabilities of the future direction of price.

How to Study Such Historical Price Action for Technical Analysis in Forex?

In the world of trading with Forex, charts are the best companions for technical analysis. This is because charts are the simplest and the most convenient way of visualizing historical data. You are able to look at the data from the past in the form of charts to identify trends and spot patterns which can help you ten folds in the upcoming trading opportunities.

As more and more Forex traders start to perform technical analysis, studying these price patterns and indicator signals, the more likely it is that these trends are well manifested in the market.

Nevertheless, you should keep in mind that technical analysis is extremely subjective. This means, for instance, if two traders are looking at the same setup of chart or the same indicator patterns, it does not necessarily mean that they will interpret it in the exact same manner. They may come up with completely different idea of where the price is going.

What is important is that you are well aware of what to look at, what the concepts are in technical analysis so that you do not miss the most relevant information.

To summarize what technical analysis actually entails, we can say two things:

  1. Identifying the trend of price in trading
  2. Identifying the support or the resistance in the price action using price charts and/or the timeframes

Market can shift up, down or sideways. However, price can only move in zigzag manners. This means price action comes in two different states:

  1. Range- when the price is zigzagging sideways
  2. Trend- when the price is zigzagging either higher (up trend, or bull trend) or lower (down trend, or bear trend)

Nevertheless, the technical analysis in Forex trading is essential because it not only assists you to decide when and where to enter a market, but also, and more importantly, when and where to exit.

Types of Technical Analysis in Forex Trading

There are several indicators in Forex which should become part of your standard strategy if you are a Forex trader. Which indicator is the best? Well, this highly depends on the trader’s psychology, personality, and style, because the trader is the one who interprets it. That being said, there is no doubt that you must be aware of a few indicators when it comes to technical analysis in Forex. These are described below.

Forex indicators for Technical Analysis in Forex

  1. Moving Averages

These are the leading indicators in the technical analysis in Forex. This indicator is especially designed to evaluate the price actions and find out the breaks in it besides identifying the general direction of the market. The moving averages mostly come in the form of a line that has been drawn on a chart that is used to gauge the mean value of a pair of Forex over a given period of time (in days).

The trader can get a rough idea of the general trend of the pair of currency. However, over a shorter period of time, the moving averages have a quicker reaction to price changes in the market.

  1. Oscillators

This indicator helps to understand the time when the market gets to a limit and an opposite correction of the present trend is the likely outcome. When a price shoots up, technical analysts will term it as overbought, meaning that the price will stay stable or come down a bit when traders work to improve the profits.

As a result of negative correction, new traders enter the market, causing the price to shoot up. On the contrary, when a market is oversold, the reaction in the other direction is facilitated, causing a positive correction.

Oscillators can also be used to predict the breaking point in the price movement.

  1. Stochastics

The Stochastic oscillators indicate the overbought zones and conditions of oversold as well as the possibilities of price reversals. The most commonly implemented versions of Stochastics are the slow stochastic stands. Located at the bottom of charts, this indicator is made up of 2 moving averages between 0 and 100.

This is pretty popular among traders because of the accuracy of the findings. It is often implemented by all levels of traders, given the power of the indicator to help investors of all levels determine good entry and exit points. However, they are also known to sometimes give false signals.

  1. Retracement Lines of Fibonacci

This indicator is based on the Fibonacci sequence. This method aims to get support and resistance levels on a trading profile. Markets react or retrace by smaller portions of a big move. These portions are often predictable. So the Fibonacci retracement lines, a series of continuous patterns, are useful for trading.

However, Fibonacci retracement involves a lot of subjective evaluation. It is popular but not supported through any mathematical logic or economic theory. Rather, this indicator has been developed based on common ratios that are seen in the natural world.

  1. RSI

The relative strength index, also known as RSI, is an oscillator indicator which can be used to find conditions in the market where oversold and overbought situations can be seen. This is mostly useful for traders who are prone to buying low and selling high. Why so? It shows values plotted between 0 and 100, where zero is considered oversold and 100 is known to be the overbought end.

It is easy to use a RSI to get alerts of currency pair value hitting a specific threshold.

However, RSIs are known to give false alarms. Hence, it is suggested to use this only at the starting points of trade evaluations. Once a RSI notification comes in, a more detailed evaluation can be done to better understand the trade potential. It is less reliable otherwise.

  1. Bollinger Band

The Bollinger bands are easy ideas and very widely used among traders. When a currency pair’s prices surpass the moving average, and entails a certain amount, the start of a trend is seen. In general, the values of the Bollinger Bands are 2 or 2.5 standard deviations from a mere moving average.

Bollinger Bands’ width offers an easy visual depiction of the market volatility: the wider the distance between two outer bands, the more is the volatility, whereas the narrower the gap, the more is the probability of a price breakout or consolidation.

However, they only reflect past performance and hence cannot identify trade opportunities early. Pairing this indicator with technical indicators can solve the issue and increase the usefulness of these indicators.

Final Words about Technical Analysis in Forex

There is no magical format of technical analysis or the perfect combination of technical indicators which can bring out secret trading strategies. A successful trading requires sound risk management, immense discipline and patience, and the ability to keep a check of the emotions of traders.

You can always guess right and win every once in a while. However, without proper risk management, depicted through a sound technical analysis in Forex, you will not go much far or stay in a profitable trade in the long run. Hope our article on Technical Analysis in Forex Trading was helpful to you!

Leave a Reply