Understanding Technical Analysis for Forex Trading

Retail traders on financial markets constantly analyse the market to get trading insights that cannot be identified by simply looking at price charts. The two major approaches for gaining useful insights into financial market are fundamental analysis and technical analysis.

Technical analysis has been proved to work for the forex market. It involves analyzing past price behavior of currency pairs to determine their future price movements. Traders use resources such as charting tools to make decisions on whether to buy or sell a currency pair at any given time. Emergent technologies are dramatically improving the process of technical analysis. The development of genetic algorithms and neural networks, for example, has potential to improve the accuracy of price predictions.

Most important forex technical analysis tools

There are many tools used for technical analysis. Tools like the trading calculator are simple to use even for beginning traders. This article provides an overview of the most common tools that technical analysts use. It is important to note that no tool can be termed as more superior compared to others. Your trading strategy determines which one(s) to use in your analysis.

1. Support and resistance levels

The forex market keeps moving up and down, thus the zigzag shape of currency charts. The highest point the market reaches when it moves up before pulling back down is a resistance level. The lowest point that the market reaches before going up again is a support level. As the market oscillates over time, it continually forms many resistance and support levels.

Support and resistance is the basis of technical analysis for the Forex market. Traders target to buy at or near areas on an upward trend where there are significant levels of potential support. Correspondingly, they look to sell at or near areas on a downward trend where there are significant levels of resistance.

2. Candlestick charts

Support and resistance levels do not represent exact numbers. That is why you see these levels often appearing as if broken. Breakages imply that the market was testing the level, and these tests are represented by candlestick shadows.

Candlesticks add the extreme lows and highs to the picture of the market. It’s common practice in technical analysis to treat the breakouts as outliers when drawing the trend. They highs and lows can mislead since they are just reflex reactions of the market. Analysts thus draw a line chart with the exact closing price to get a more accurate picture of the market.

3. Trend lines

Trends lines are among the most common tools for technical analysis. If drawn correctly, these lines are highly reliable for forex trading decision making.

How to draw trend lines

An uptrend is drawn by connecting the bottoms of easily identifiable support areas. On the other hand, a downtrend is plotted by connecting the tops of resistance areas that you can easily identify.

Many traders make the mistake of trying to make the trend line fit the market. The correct way is to identify two major top points (in the case of a downtrend) and connect them using a straight line. For the uptrend, just locate two major bottoms and connect them. If a third point lies on the trend line, then you have not only a valid but also confirmed trend line, which is more reliable.

4. Technical analysis indicators

Forex markets behave in certain ways under certain conditions. Price patterns occur time and again. Technical analysts use Forex indicators to recognize these patterns and leverage that knowledge in trading.

Here are some types of forex indicators:

●     Moving averages: Examples are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).

●     Momentum indicators: the Moving Average Convergence/Divergence (MACD) is an example. It identifies and measures the strength of a trend.

●     Volume indicators: these help to identify oversold and overbought areas. The Stochastic Oscillator evaluates how close a closing price was compared to the price range.

Other important tools for forex technical analysis are Fibonacci retracement and the session highlighter. Fibonacci retracement indicator follows the basic idea that a market is more likely to retrace after an extreme move. Session highlighters help to easily distinguish opening and closing times for different forex trading sessions.

Technical analysis assumptions

The use of technical analysis tools is based on the following assumptions:

●      Currency pair prices move in trends.

●      History repeats itself – if it happened in the past, it will happen in future.

●      Market discounts everything.

When choosing forex trading software, it is wise to know which technical analysis tools it provides. Take time to familiarize yourself with different analysis tools to ensure that you select trading software you can rely on to trade successfully. Using a trading demo should introduce you to real forex trading practice and is highly recommended before you commit your money.