Understanding Technical Analysis and Indicators
Technical analysis in the Forex market represents the ability to track historical data by plotting lines, graphs and points that allow us to monitor price action and look for consistent, repeating patterns. These patterns allow us, with a degree of certainty, to predict future performance based on identical patterns and the fundamental climate. Technical analysis is a powerful way of looking at the Forex market because all information is based on price action, the foreign exchange market develops trends easily and chart patterns are easily recognized as consistent and recurring events.
The most important part of technical analysis is recognizing the current trend. There is only one major trend and it is based on a large time frame that contains at least three months of data and preferably six months to a year. However, it is possible to recognize small movements that occur within a trend that may last for several days or weeks. These small trends tend to be followed by traders who work with much shorter time frames. It is often not a good idea to follow a contrarian approach when trading one of these smaller trends. You are much better waiting for that small trend to resume in the direction of the major trend before placing your trade.
Moving averages are a lagging indicator, meaning that they give you information after it has happened. Moving averages help to determine the trend of the market over a certain number of time periods, with the most popular moving averages being 5, 13, 20, 50, 100 and 200 time periods noted. Knowing that these are the most popular moving averages, plotting them on your chart will give you a view of what thousands of traders are doing at the same time. Understanding that many people are using the same indicator shows that you may be able to operate around this indicator looking for profit opportunities.
The moving average convergence-divergence is a graph plotted that uses exponential moving averages in order to identify opportunities for buying or selling by noting the possibility of trend reversals as they are occurring.
Bollinger bands provide a channel through which prices tend to stay during movement, the channel is determined through a mathematical formula and a midline band is developed around the moving average of your choice. As prices reach the outer limits of the channel, it is often a signal that the price will reverse for a short period of time. Often when the bands have narrowed significantly, during a period of consolidation, a breakout of the channel often signals a significant price move in the direction of the breakout.
Another favorite technical analysis tool for the Forex market is Fibonacci retracement numbers. These numbers are cyclical in nature and when applied to a market trend offer the trader potential points where the market may move. Often after a significant rise or fall in price, the market will pull back and almost always that pullback can be marked with Fibonacci levels.
Finally, the relative strength index measures the Forex market and relates information as to whether it is overbought or oversold. The RSI is often thought to be a leading indicator, since a higher number indicates an overbought situation suggesting a sell-off is coming come, while a lower RSI points toward and oversold condition leading to a buying frenzy. However, this does not always occur as the market may find itself in a period of consolidation after a significant buying or selling time.
In conclusion, technical analysis has proven to be an extremely effective method for traders to profit; however, it is not the only aspect of trading that must be considered. Fundamental analysis which includes social, economic, and political data provides a significant influence on the movement of prices at different times during the day, week and year. Realize that the market is a complex playing field that requires more than looking at numbers and you will increase your ability to succeed.
Date Posted: January 5, 2012