The Basics Of Technical Analysis

In starting our section on Technical analysis it makes sense to define what exactly Technical analysis is.

Technical analysis seeks to identify price patterns and trends in forex markets with the ultimate aim of exploiting these patterns and trends to time market moves correctly. While a technical analyst may call upon several different tools or theories in attempting to predict these moves, the common tool used by all technical analysts is the chart.

Technical analysis is frequently contrasted with fundamental analysis, which as we have seen is the study of economic factors that influence currency prices. Technical analysts believe however that prices already reflect all known influences before investors are aware of them. Therefore their study is directed exclusively at currency price action.

The term Technical analysis is essentially an umbrella term which is used to describe any form of price analysis that relies primarily on the reading of a chart. Underneath this umbrella several different schools of Technical Analysis exist and various approaches and theories have been developed and adopted over time.

Among the several different schools of technical analysis, Candlestick charting and Elliott Wave Theory tend to be more popular among longer term traders. Shorter time frame traders looking to make quick intra day profits will often rely on mechanical indicators alone. A follower of technical analysis may adhere strictly to their own school or draw upon elements from different approaches in an effort to refine their own approach to the markets.

Users of technical analysis will also extensively make use of technical indicators. These are typically mathematical transformations of price or market volume. Common indicators are moving averages (which show the average price movement over time) and oscillators. These can help to indicate when a currency is overbought or oversold in the market. These indicators are used by technical analysts in an effort to help determine market trends or imminent changes in the market.

Followers of Technical Analysis will also search for pattern formations in charts. Commonly known patterns such as the 'head and shoulders', flags and pennants are used for signs of the market playing out classic price action which the trader can seek to profit from.

Technicians seek to forecast price movements such that large gains from successful trades exceed more numerous but smaller losing trades, producing positive returns in the long run through proper risk control and money management.

Some traders will advocate using technical analysis exclusively, while others will combine technical readings with fundamental factors to make their trading decisions. Indeed many large financial institutions will employ both fundamental and technical analysts and base their market calls on a combination of reports from both camps.

As a discipline Technical Analysis can be as complicated or as simple as the analyst wants. The mistake that many new Forex Traders make is to cram their charts with indicators and attempt to understand a multitude of approaches. The fact is that keeping your approach simple and understanding the basics will often yield better results. A good phrase to remember here is 'jack of all trades, master of none.' Keep it simple and you will still make good trading profits.

Next: Forex Charting