How to Perform Technical Analyses
If fundamental analysis gives traders the reason why a market is moving, technical analysis gives the direction of that movement, or the target for any given trade. It is said that fundamental and technical analysis should be both considered before opening a trade, as they are equally important for a trading decision. Technical analysis deals with interpreting patterns on the left side of the chart, or patterns that formed back in time (using historical prices), with the purpose of identifying future price levels that can be derived from those patterns. This kind of analysis might look to be unreliable, but works very well when it comes to finding support and resistance levels that matter for a currency pair.
There are so many different approaches when it comes to technical analysis that at any one moment in time one would have to choose which suits best, as it is not possible to use all of them when trading. There are the Western and the Japanese approaches to consider, trend indicators and oscillators to interpret, and different trading theories to use and master. One thing must be understood from the very beginning: There’s no holy grail in using technical analysis, and any kind of set-up only works in a specific situation. Any technical analysis set-up should consider fundamental factors as well, as any analysis that does not use both approaches will be doomed to failure.
Video Transcription: What is Technical Analysis
Hello there, this Topratedforexbrokers.com and we continue our trading academy with one of the most interesting themes for beginners. What is Technical Analysis? Have you ever wondered as a rookie trader, or a starter in the FX trading, why everyone talks about Fundamental Analysis or technical analysis.
(0.25) Well, fundamental analysis as explained here earlier, represents the sum of other factors outside what is happening on a chart. Other factors like Economic news, geopolitics and so on that influence a currency pair.
(0.41) Where Technical analysis represents the way traders interpret charts, like this one. This is the Euro/US Dollar example on the four-hour chart. Now, in Forex trading, all we want to do is either go long or buy, or go short or sell. In doing that, throughout the years, even before personal computers and even before the trading platforms that we have these days…
(1.12) ..Traders tried to look for market patterns, or for chart patterns, in order to interpret the future conditions for the market, and at the very start of technical analysis, there was a trend line. For example, on this Euro/US Dollar here, it is obvious that the market rises with a very sharp trend.
(1.37) This is the line of the trend; this is technical analysis; the way you draw the trend line is technical analysis, It makes no sense to go short or even to consider going short, until the trend line or the line of the Bullish Trend is broken.
(1.58) Of course, this is the very basics of technical analysis, and we want to emphasis here, is that everything starts with a trend line. All the concepts that were developed were moved forward from this trend line.
(2.19) What do we need for a trend line? For a trend line, we need two points. Not 100, not 1000. For example, here, this is one point, and this is another point, and then we simply drag. From this moment onwards we already knew that as long as the price stays above this trend line, we don’t want to sell. We want to be on the long side, or at least we want to ebb on the long position, like buying on dips and so on.
(2.49) So this is a rising trend line here. From this moment on, everything gets complicated. In the 1940’s a wonderful trading theory was invented, and we will discuss much of this theory here on the trading academy, Elliot’s waves theory of 1940’s. There were no personal computers, no charts, nothing. Simply, looking at the price action and interpreting the patterns.
(3.19) In time, technical analysis was split into two approaches. Let me write it here on the screen. Everything started from the United States of America. And that is called the Western approach (he types), and under the western approach, the article that comes with this video will treat all the patterns under the western approach such as the head and shoulders, the rising and falling wedges, the penance, the Bullish and Bearish flags and so on.
(3.55) Many years later, the Westerners were surprised to find out that the Japanese had a very interesting approach to trading or Technical analysis (types Japanese). The Japanese approach made a lot of sense. The Japanese approach, most of it deals with interpreting candlestick charts. For example look at this one, and zoom in, we see that these are candles.
(4.27) The japanese approach interpreted these candles here, with most of them being reversal patterns, and doing that the Japanese focused on projecting future prices. The power of the Japanese Candlestick technique was so great, and the westerners were so impressed, that they went on to adopt the candlestick chart.
(4.53) Up until then, there were no candlestick charts, only line and bar charts, and now we have the candlestick chart, which is the most popular and first choice amongst Forex retail traders. Over this course, we will examine many of these technical concepts.
(5.17) We will address most of them in our project. All the reversal patterns with the Japanese candlesticks techniques or classical ones with the Western approach, we will touch trading theories like the Gun, and the Elliots Waves theory, and what’s even more important for you to understand is that the Forex Market, always changes.
(5.45) It changed a lot already, and will keep on changing from this moment on. Think of 10 years ago, when the spread on the Euro/US Dollar pair was three pips, or the difference between the Bid and the ask price was three pips. Therefore charts were very different a decade ago.
(6.06) Nowadays, the spread between the bid and the ask price on the Euro/US Dollar was zero point something. Therefore candles do not have that kind of slippage. So the way that the market is presented to us changed, and technical analysis had to change, and it will change in the future.
(6.28) Expect new techniques to appear as part of technical analysis. There is not only trend lines and trading theories, but also plenty of indicators. Let me show them here to you; there are Bill Williams indicators, Cycle indicators, math operators, momentum indicators. These are basically the oscillators.
(6.53) If you choose any of the oscillators from here, it will be plotted at the bottom of the screen. We will treat most of the oscillators. The idea of an oscillator is to compare the move the oscillator makes, with the move the actual price makes. The purpose is to find out which one of the two lies.
(7.20) Typically the price makes a fake move, as this is a dog eat dog world. But how do you know when that is the case? That is why oscillators are here to do that job. We also have in part of technical analysis, overlap studies or trend indicators. It doesn’t matter if you use the Metatrader, or this one; the JForex.
(7.43) It is just another trading platform. But if you use the Metatrader, (changes screen to show the Metatrader) it is exactly the same. You go on the insert indicators, and you have trend indicators, and oscillators, some of them and you can import others as well. I think you have got the picture now as to what technical analysis is and we will move on to the next part of our trading academy showing you how to apply various indicators in a chart. Both on the J Forex and the Metatrader, as two of the most popular platforms for retail traders. Thank you and let’s move on.
What Makes Technical Analysis?
In plain English, technical analysis represents the ability to chart a currency pair using different technical tools in order to have an idea about future market direction. The beauty of doing this is that the outcome should have a direction, a take profit, and a stop loss, as this makes trading well-anchored in money management rules, making it very difficult for a trading account to be wiped out. There are many things to consider when looking at the overall technical analysis, and they are classified based on the inputs traders use for charting a currency pair.
Western Approach vs Japanese Approach
Technical analysis has its roots in the Western hemisphere, as the United States of America was the first part of the world to use charting techniques in order to forecast future prices a financial product may make. For that purpose, various concepts such as reversal and continuation patterns have been introduced, with them representing the very basic of technical analysis these days. In this category are rising or falling wedges, head and shoulders patterns, and double and triple tops, all of which represent reversal patterns. There is virtually no trader out there (or at least there should not be one) who doesn’t know these patterns and how to interpret them. Channelling techniques and continuation patterns such as pennants and bullish or bearish flags are also part of the same basic technical analysis concepts. The only thing that is different is that some traders mistake a bullish flag for a pennant, but in the end, the price should break in the same direction so that the actual technical analysis has the same outcome. Recently (in the last couple of decades), the whole technical analysis concept as it was known so far was influenced by the Japanese approach to this subject. The Japanese were using different charting tools to anticipate price reversals or continuations, and these tools were based on a new type of chart: the candlesticks chart. The price of a financial product is divided into different timeframes such as the monthly, weekly, daily, 4-hour, hourly, and even shorter, and a candle represents the time unit that corresponds to that chart. For example, a candle on the monthly chart represents 1 month, while a candle on the hourly chart represents 1 hour. Moving forward, the Japanese applied so-called Japanese Candlestick Techniques mostly to identify reversal patterns based on these candles, and to spot tops or bottoms. In a way, it is the same thing the Western approach tried to do: to use patterns to identify reversal or continuation patterns, only that for the Japanese these patterns were actually candles, or group of candles.
These techniques were so effective that they were embraced with much enthusiasm by the Western world, and to this day they are widely used. One can talk about reversal patterns such as bullish or bearish engulfing, dark-cloud cover or piercing, morning and evening stars, hammer or hanging man, or about continuation patterns such as a simple Doji candle.
Trend Indicators and Oscillators
In addition to the types of technical analysis mentioned above, there are a lot of trading indicators that can be used in order to forecast future prices a currency pair is about to make. These indicators are either trend indicators or oscillators.
Trend indicators are applied on the actual chart, and they represent exactly what the name suggests: indicators that are used for the purpose of riding a trend until its exhaustion. It is said that a trend is a trader’s friend, and this is true to the extent that the trader knows when a trend started and what to do to ride this trend. There are so many trend indicators that it makes no sense to mention them all here. Just keep in mind that the most popular ones are moving averages (simple and exponential ones), Bollinger Bands, or the SAR Parabolic indicator. All of them show basically the same thing: how to ride a trend. When using them, traders are looking to buy dips in a bullish trend or to sell spikes in a bearish one.
The other category of trading indicators is oscillators. These indicators are applied on the lower side of the screen, below the actual chart, and represent a value plotted based on different inputs the oscillator takes into account (number of candles considered, averages, etc.). Successful approaches when trading with oscillators are based on traders looking for divergences between the moves that the price and the oscillator make. There are bullish and bearish divergences, so long or short trades can be taken.
Last but not least, the technical analysis comprises many trading theories one can use in order to forecast future prices. From Elliott Waves to Gann, there are many trading theories worth mentioning, and here on Forex Trading Academy, we’re going to cover the most important ones. All in all, technical analysis is a must for any trader involved in the Forex market. Regardless of the tool used (indicator, pattern, or trading theory), technical analysis, if used correctly, gives the direction in which the market is supposed to move.
Other educational materials
- Moving Averages – Find Support and Resistance Areas
- How to Use Parabolic SAR to Buy Dips or Sell Spikes
- Bollinger Bands – Profit from One of the Best Trend Indicators
- What is Forex Trading?
- What is a Currency Pair?
- Majors and Crosses – How to Trade Them?
Recommended further readings
- “The use of technical analysis in the foreign exchange market.” Taylor, M. P., & Allen, H. (1992) Journal of international Money and Finance, 11(3), 304-314.
- Market statistics and technical analysis: The role of volume. Blume, L., Easley, D. and O’hara, M., 1994. The Journal of Finance, 49(1), pp.153-181.