Technical analysis is a trading tool employed to evaluate
securities and attempt to forecast their future movement by analyzing
statistics gathered from trading activity, such as price movement and volume.
Unlike fundamental analysts who attempt to evaluate a security’s intrinsic
value, technical analysts focus on charts of price movement and various
analytical tools to evaluate a security’s strength or weakness and forecast
future price changes. Over the years, numerous technical Indicators have been developed
by analysts in attempts to accurately forecast future price movements. Some
indicators are focused primarily on identifying the current market trend,
including support and resistance areas, while others are focused on determining
the strength of a trend and the likelihood of its continuation
Historical Data
Technical analysis is the study of historical price action
in order to identify patterns and determine probabilities of future movements
in the market by studying price action and through the use of technical
indicators and chart patterns. Technical Analysis focuses on using a price
chart to identify the trend, support and resistance, and momentum to help
traders get into and out of higher probability trades. A technical analyst
believes that prices move in trends, and price movements generally follow established
patterns that can be partly attributed to market psychology based on the
widely-held belief that participants in markets react in a similar fashion when
faced with similar situations. Technical analysis does not attempt to measure
an asset’s underlying value, but rather, uses price charts and technical
indicators to identify patterns that can be used as a basis for trade entries
and exits.
Patterns Tend to Repeat
Forex traders who use technical analysis believe that price
patterns tend to repeat themselves in the future, they’ll analyze a currency
pair’s previous price movements, and use those to decide when to enter and exit
positions. The overarching principle of technical analysis is that an asset’s
price already reflects all available information and instead focuses on the
statistical analysis of price movements. It boils down to an analysis of supply
and demand in the market to determine where the price trend is headed. The main
theory of technical analysis is: Recent price developments allow you to
understand what the buyers and sellers on the market are thinking. You can then
tell whether it is buying or selling interest that is increasing. This allows
you to deduce what the market participants may do next.
The Theory
Technical analysis is based on the theory that the markets
are chaotic (no one knows for sure what will happen next), but at the same
time, price action is not completely random. Within a state of chaos, there are
identifiable patterns that tend to repeat. This means that successful trading
using technical analysis is NOT about being right or wrong It is about
determining probabilities and taking trades when the odds are in your favor.
Part of determining probabilities involves trying to determine future price
direction and when/where to enter into a position. But equally important is
determining your risk-to-reward ratio. There’s no magical combination of
technical indicators that will unlock some sort of secret trading strategy. The
secret of successful trading is good risk management, discipline, and the
ability to control your emotions. Anyone can guess right and win every once in
a while, but without risk management, it is virtually impossible to remain
profitable over time.
Technical Indicators
Technical analysis is the study of historical price
action to identify patterns and determine probabilities of future
movements in the market by studying price action and through the use of
technical indicators and chart patterns.
Technical Indicator
Technical Indicator A technical indicator is a mathematical
calculation that can be applied to price and volume data. It can be even
applied to another technical indicator. The result is a value that is used to
anticipate future changes in prices. Technical indicators are the squiggly
lines found above, below, and on top of the price information on a chart. They
are used by forex traders who follow technical analysis. A technical indicator
offers a different perspective from which to analyze the strength and direction
of the underlying price action. By analyzing historical data, technical
analysts use indicators to predict future price movements
Categories of Technical Indicators
Leading & Lagging Indicators
Leading indicators try to predict price by using a shorter
period in their calculation, which leads the price movement. The most popular
leading indicators are MACD, RSI, and Stochastic. These indicators typically
work by measuring how “overbought” or “oversold” an asset is. The assumption is
that when something is “oversold” it will bounce back. LAGGING indicators give
a signal after the trend or reversal has started. The most common lagging
indicator is the Moving Average. They don’t warn you of upcoming changes in
prices, they simply tell you what prices are doing (rising or falling) so that
you can trade accordingly. Lagging indicators have you buy and sell late, but
in exchange for missing the early opportunities, they greatly reduce your risk
by keeping you on the right side of the market. The general approach is that
you should use lagging indicators during trending markets and leading
indicators during sideways markets.
Types of Technical Indicators
Trend Following Indicators
Trend-Following Indicators Trend following indicators help
traders trade currency pairs that are trending up or trending down. These
indicators can help point out the direction of the trend and can tell us if a
trend actually exists. Trend-following indicators measure the direction and
strength of a trend, using some form of price averaging. As price moves above
the average, it is considered to be in a bullish trend. When price moves below
the average, it signals a bearish trend. Here are examples of trend-following
indicators: Moving averages are used to identify current trends, as well as
support and resistance levels. MACD is used to reveal changes in the strength,
direction, momentum, and duration of a trend. Parabolic SAR is used to find
potential reversals in the price’s direction.
Momentum Indicators
Momentum indicators help identify the speed of price
movements by comparing prices over time. It can also be used to analyze volume.
It is calculated by comparing the current closing price to previous closing
prices. Typically, this appears as a line below a price chart that oscillates
as momentum changes. When there is a divergence between price and a momentum
indicator, it can signal a change in future price direction. Here are examples
of momentum indicators: Stochastic shows the location of the closing price
relative to the high-low range over a set number of periods. CCI is an
oscillator that helps identify cyclical turns or trend reversals. RSI measures
the strength or weakness of a currency pair by comparing its up movements
versus its down movements over a given time period.
Volatility Indicators
Volatility indicators measure the rate of price movements,
regardless of direction. This is generally based on a change in the highest and
lowest historical prices. They provide useful information about the range of
buying and selling that take place in a given market and help traders determine
points when the may change direction. Here are examples of volatility
indicators: Bollinger Bands help determine whether prices are high or low on a
relative basis. Average True Range measures volatility, taking into account any
gaps in the price movement. Standard Deviation is the statistical measure of
market volatility, measuring how widely prices are dispersed from the average
price.
Volume Indicators
Volume indicators measure the strength of a trend or confirm
a trading direction on some form of averaging (or smoothing) of volume. The
strongest trends often occur while volume increases. Here are examples of
volume indicators: Chaikin Money Flow (CMF) measures the volume-weighted
average of accumulation and distribution over a specified period. The principle
behind the Chaikin Money Flow is the nearer the closing price is to the high,
the more accumulation has taken place. On Balance Volume (OBV) measures buying
and selling pressure as a cumulative indicator that adds volume on up days and
subtracts volume on down days. Volume Oscillator (VO) displays the difference
between two moving averages of a security’s volume expressed as a percentage.
It works on the premise that t is not the actual level of volume, but the
change in volume relative to the recent past that has more technical
significance.
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