By the end of this lesson we will learn what Technical Analysis actually is, what two of the main Technical Analysis methods are and which of the two I would recommend, let’s get started!
What is Technical Analysis?
Technical Analysis is the process by which one studies the price movement of a Forex Currency Pair, this is done by looking at the relevant chart. The main reason why traders use Technical Analysis, is to project what the most likely future price action is going to be, this is done by taking in to consideration the past price action that has already been printed on the chart.
Professional Traders will almost always make their trading decisions based around Technical Analysis. The fundamental reason why it works so well, is due to the reality of the markets. The markets are subjective, i.e. they are influenced by traders emotions and feelings. This is precisely why a ‘strategy’ based upon a ‘Buy on this trigger, Sell on that trigger’ will simply never work, as much as we hope it will.
There are two main types of methods within Technical Analysis:
- Using Technical Indicators
- Price Action
Of the two I believe that Price Action is greatly superior and we will be looking at why this is so a little later on. First let’s look at Technical Indicators in a bit more detail.
Before we begin this section I would like to point out that I do not use Technical Indicators, for the very reason that was stated earlier; the markets are subjective. Technical Indicators, are simply different ways to analyse and show you what the raw data (the candles on the chart) are showing you, they do not offer you any new or additional information.
Making your trading decisions based upon what the Technical Indicators show you can be a very risky method, this is because they can usually confuse/contradict the actual chart. For example, a trader may start with two indicators and have a few lucky successful trades, they then have a losing trade and try to improve their indicator based strategy by adding another indicator, but this just serves to confuse/contradict even further, eventually the trader suffers from what we call ‘analysis paralysis’, their chart is awash with so many different indicators that it has become difficult to see the raw data.
Below is an example of such a chart:
As you can see there are multiple indicators on top of each other, making it difficult to analyse what the price is showing us. Not only this, but with so many indicators they are likely to contradict each other.
Now let’s look at the same chart free from indicators:
Visually this chart is a lot more clearer and so easier to analyse then the previous one. Once you understand how to read what the candles are showing you, you will be able to project future price action with a lot more ease and many times more accurately, then using indicators.
So to conclude, stay away from Technical Indicators and teach yourself the art of reading the chart by itself, this is known as Price Action.
Price Action is when traders use the raw data (candles), in order to identify price movements/patterns on a chart to make their trading decisions. This is because all market activity is shown via price movement on the chart in some way, with this being the case a study of price movement on the chart is enough to analyse the market. Of course, as we have looked at in the previous chapter, having up to date knowledge on the Forex News (Fundamental Analysis) is just as vital to our success.
Price Action traders scan the chart looking for certain patterns, that will alert them to a possible trade entry. These patterns will repeat with time over and over again, the reason for this is the subjectivity of the markets. Remember how we spoke about the markets being affected by human emotions/feelings, well as human beings we tend to be repetitive in our analysis of the market, e.g. “Price really fell hard when it reached this level in the past, it will probably do it again!” This is why patterns will repeat themselves in the market and this is how Price Action traders can be successful in their analysis.
Becoming a master at Price Action and reading the chart, is something that will come through exposure and experience to the markets. Learning to analyse the structure of the market such as Support and Resistance (which we will look at later), takes time but once you understand what the market is telling you, you can then have a clearer understanding of what future Price Action will be. It is something that you will get better at as time goes on as you progress through your trading career.
So now that we know what Technical Analysis is and the best method to apply Technical Analysis (Price Action), the next question is HOW do we use this information to analyse the chart? How do we identify major price action? What patterns are we actually looking for? etc
In order to answer these questions we must first understand how we should view the charts. Every chart tells you a story, being able to read this story will enable you to trade successfully and profitably, it is a story about a battle between the BULLS (The Buyers) and the BEARS (The Sellers), in the next lesson we will be looking at this in more detail.