Technical analysis can be described as the study of price movements. It involves the use of past price data to make predictions about future movements of the price. Technical analysis is solely based on chart analysis unlike fundamental analysis which relies on news.
When people think about technical analysis, they usually assume that it is based on technical indicators only. This is very wrong because it is way diverse than that. Technical analysis covers a range of other analysis including, support and resistance, trend lines, chart patterns as well as candlestick patterns. All these put together, form the basic principles of technical analysis. Let us now look at each one of them in detail:
Support and Resistance
These are two of the most important levels in the FX market. A support or support level, is a point which is tested by price as it moves down. A decrease in price shows that the sellers are in control. However, it reaches a point where the sellers are unable to push the price any lower and hence the buyers come in and push the price up. This point where price bounces and shoots up is called a support level. This point remains a significant level for other traders looking for a buy as the market usually remembers such points.
Unfortunately, sometimes the market breaks this point and moves even lower when others have already bought a currency pair. With enough skills, you will be able to know when to enter a buy at this point and when not to. A breakout is a great opportunity to sell.
A resistance level, is a point where price tests as it goes up. This means that, before this point the buyers were in control. You will notice that at this point the price with hesitate and eventually make a reversal to the downside or break though the resistance. If it breaks through it means that the buyers are still in control, but if reverses it means that the sellers have gained control now and you should be looking to sell. You will be able to know these points by assessing other previous points on the chart where price made a reversal.
Trendlines can be described as a series of diagonal highs and lows. They dictate the direction of the market. There are basically three types of trends; bullish trends, bearish trends and sideways trend.
- Bullish trend -This is a series of higher highs and higher lows which causes the price to move in an upward direction. The highs usually form the resistance for the lows hence the general direction.
- Bearish trend -This is a series of lower highs and lower lows causing a downward movement of price.
- Sideways trend -This can also be described as a flat trend. There are no higher highs, higher lows, lower highs or lower lows hence no general direction. The market seems to stagnate within a certain area. However, you can expect price to break through in future.
There are a variety of chart patterns you will encounter while trading. These patterns give you an idea of where price might go in future. Some of the common patterns include; The head and shoulder pattern, the double top or triple top pattern, the flag pattern, the bearish and bullish pennant pattern, the ascending and descending triangle, the bearish and bullish rectangle, the rising and falling wedge among others.
Some of these patterns work better in longer time frames and hence it may be best to do a time frame analysis before using them on live trading. If you master such patterns, then you could combine them with candlestick formations and have a powerful source of prediction.
We know that you could use the bar or the line chart for trading, but the candlestick chart gives you an edge over the market. Certain candlestick formations usually dictate the direction of price based on the place they manifest. If you are able to spot them at levels of support, resistance or on some of the patterns mentioned above, then this increases your chances of getting a winning trade.
Some important candlesticks you should learn about include; the hammer, the hanging man, the doji, the inverted hammer, the shooting star, bullish and bearish engulfing, tweezer tops, tweezer bottoms, morning star, evening star, the three white soldiers and the three black crows.
Technical indicators can be classified into two: the leading and the lagging indicators. The leading indicators is always ahead and provides you with information before a reversal or trend occurs. The lagging indicators, however, wait for the trend or reversal to start and then give the signal for you to jump in.
Leading indicators are mainly oscillators and will include the likes of the Relative strength indicators (RSI), Parabolic SAR and Stochastic. Lagging indicators are often momentum indicators such as the MACD and moving averages. It may sound good to get in immediately as soon as you get information from the leading indicator, but as you will learn after trading for some time, they are not always right.