What is Technical Analysis?

Good Technical Analysis is essential to the successful Forex trader

Photo by CC userĀ Kbrose on Wikimedia Commons.

Technical analysis is the examination of historical price action which is based on the theory that all the available information is reflected in the current price of a security. Those who use technical analysis believe that this type of analysis can assist in the process of predicting future changes in the price of the security.

Daily fluctuations in the price a currency pair or a stock, reflect changes in human psychology, and represent the fear and greed of market participants. The study of technical analysis ranges from finding areas of robust demand and supply, to using statistical studies that express the perceived fair value of a financial security. This visual representation of price action and current psychology of price action can give an investor a glimpse of potential future market movements.

There are a plethora of technical analysis tools that are used by market participants to gauge market sentiment. The key to using technical analysis successfully is to gauge your trading style to determine which tools are best suited toward your style. For example, if you like the idea of buying something really cheap, and are not concerned if it moves against you for a while until is soars higher, then indicators that tell you if a security is oversold or overbought can be very helpful.

With a backdrop of using your trading style to determine which studies are best for you as a forex trader, some of the best tools reflect supply and demand.

Support and Resistance

The change in price of a financial security is based on supply and demand. When investors believe the value of a security is inexpensive relative to expectations, they will purchase a security in the hope that it will eventually move higher. Pent up demand for a security will generate price stability and eventually pinpoint a price level in which market participants will purchase that security. When the price of a security reaches a level where it cannot move below, it has reached a support.

Resistance is the opposite of support in that it designates an area where the price of a security cannot move any higher. The supply for a financial instrument is strong as sellers are willing to either short or sell a security at that level.

Support and resistance are the most basic technical analysis ideas. Support and resistance will help you enter a trade, as well as perform risk management. There are a number of easy ways to find support and resistance levels, which include drawing trend line on a chart, as well as using moving averages.

Other Types of Technical Analysis

Beyond finding support and resistance levels using trend lines and moving averages, traders can use many difficult types of technical analysis tools to gauge market sentiment. A market usually has two stages, either prices are trending of consolidating. There are a number of technical analysis tools that can be used to help you determine the current market condition. For example, momentum studies help determine if a trend is accelerating or decelerating, while moving averages can assist in determining if a market is trending.

Technical analysis can assist you in becoming a well-rounded trader, as it can help you pinpoint levels where you can initiate a trade as well as perform risk management.