Principles of forex technical analysis
Like other sciences, technical analysis has some basic principles as well. Let’s take a look at some of them.
Technical analysis uses methods that forecast prices of securities in financial markets by using quantitative techniques and charts. Price patterns and price trends exist in the market that can be identified and exploited, these are some of the different methods utilized in technical analysis but they all rely on the same principles. One of the earliest examples of technical analysis is the Charles Dow’s Dow Theory. The realm of technical analysis has been expanded by many further market participants. As a growing tendency theories about technical analysis and tools have been enhancing and producing in order to make the forex trading easy and simple in its natural.
Technical analysis is more concerned with the fact that the price is moving in a particular direction, than why a price is moving ( difficult business environment, poor earnings, poor management, etc. or other fundamentals). If you consider yourself as a technical, then profits can be made in any market by positioning yourself in the direction of the price trend.
Look for opportunities to buy, if the price trend should be up, and the opposite - look for opportunities to sell, if the price trend is down. Similarly, if a particular price pattern was identified in the market, a technician would position himself to take advantage of the expected move that follows that pattern.
In technical analysis has three basic underlying principles:
1. Prices move in trends
Technical analysis is used to identify patterns of market behaviour which have long been recognised as significant. For many given patterns there is a high probability that they will produce the expected results. Also there are recognised patterns which repeat themselves on a consistent basis.
Three types of trends are distinguished in technical analysis:
* ‘flat’ or ‘range’ or ‘trendless’ - price is not moving up or down, but remains within a certain interval;
* ‘bull trend’ - upward movement of price (by analogy with a bull, who pokes up with the horns);
* ‘bear trend’ - downward movement of price (by analogy with a bear, who hits down with a paw).
However, on the bull trend prices grow higher and faster, than they fall. On the bear trend it is vice versa. As a rule, prices are not moving linearly u or down.
Basic price movement principles can be applied to trends:
- a trend will be moving in one direction until it gets weaker;
- an active trend will continue with a higher probability, rather than change its direction.
2. History repeats itself
Some academic studies of financial markets suggest that technical analysis has little worthwhile predictive power. Chart patterns have been recognised and categorised for over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little with time.
Still, technical analysis has a loyal and dedicated following especially amongst active traders who defend the practice and believe it can be profitable and there are some scientific studies that support technical analysis.
3. Market action discounts everything
The pure technical analyst is only concerned with price movements, not with the reasons for any changes. This means that the actual price is a reflection of everything that is known to the market that could affect it, for example, supply and demand, political factors and market sentiment.