Technical analysis is a technique used by professional traders to pinpoint profitable market opportunities. The basis of technical analysis is identifying recurring patterns on price charts that have a high probability of pre-empting a future price movement. Technical analysts are not necessarily interested in the fundamental aspects driving the market such as news or events. Instead, they look for specific patterns, levels and indicators within the price charts to guide their trading decisions. These price chart elements allow traders to read markets across any timeframe and, if traded with discipline, can result in the development of a profitable trading strategy.
What is technical analysis?
Technical analysis can range from the simple identification of well-known and heavily traded price patterns to advanced trading strategies utilising multiple complex indicators. Traded in its purest form, technical analysis simply requires access to live price data and a basis of the most popular trading patterns. The reason behind the success of technical trading signals is twofold; firstly these reflect real market sentiment which creates the patterns seen on price charts and, secondly, the fact that the market reacts to these patterns once they occur. Technical analysis in this sense can be described as a reliable self-fulfilling prophecy controlled by the sheer number of traders who adhere to this.
Recognising popular patterns
Some of the most popular technical trades involve the identification of trading patterns such as trend lines, double-tops and head and shoulders patterns. These occur frequently on almost all timeframes and they are also highly reliable. Many technical traders focus on just one or two of these patterns and learn to trade these successfully. Other technical traders will look for technical “areas” of a chart which create support and resistance. These are price levels which have a strong psychological element and include daily pivot levels, Fibonacci retracements and previous highs and lows where the market has reversed. These are typically price levels which attract a larger than normal numbers of market orders which are triggered as price approaches this price level and form either an area of support of resistance.
Trading with indicators
Further variations in technical analysis can involve the use of multiple technical indicators. Whilst some of these have been custom-designed by their creators there are several which have been standardised and are by far the most popular for use by professional forex traders. These indicators can be applied to charting software and are available with the charting software provided by most brokers. Technical indicators range from trend-following indicators to momentum and directional indicators. Broadly speaking, trend-following indicators are described as “lagging” indicators in that they tell you where the market has been whilst momentum indicators are “predictive” and provide an indication of where price may go in the future. Most technical traders would not, however, advise using an indicator as a stand-alone signal to trade but advocate applying this alongside another form of technical analysis, such as the recognition of a confirming price pattern, before entering the trade. An example of this is shown on the chart below with the popular ‘double-bottom’ pattern following an ‘oversold’ indicator on the RSI.
Technical analysis can provide day traders with an edge in the markets
One of the most popular uses of technical analysis is to provide trading signals for intraday traders. The fact that patterns, psychological price levels and indicators can be applied to anything from the 1 minute to the yearly price chart makes it the most popular basis of assessing where the market may move in the future. Although it cannot be 100% reliable as a basis for trading the use of technical trading, and the ability to interpret these, certainly provides may forex traders with a significant edge in the market. Whilst it is recommended that new forex traders learn a handful of the most popular technical signals to begin with, it is true that there are several which are not only very simply to learn but also highly effective. Technical analysis can be made more complex for advanced traders but the edge that this provides may well be negligible over the basics of technical analysis.
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