Basic Principles of Technical Analysis in the Forex Market

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If you are now reading this article about technical analysis, then you know that trading on the Forex market is not as easy as it seems. On the other hand, if you’re a beginner trader, you understand the importance of knowledge within the Forex market world.

Regardless of your situation, knowing the principles of technical analysis is vital for any trader. As such, in the following lines, we’ll provide traders with the essential things they should know for a technical approach in Forex market analysis!

The Main Types of Forex Techincal Analysis

When researching the Forex market, you can approach two types of analysis, depending on your trader. As such, we have:

  • Technical Analysis – this type of analysis is based entirely on the price chart of the Forex market. It shows the current and active status of the market and what was happening within the market in earlier periods.
  • Fundamental analysis – this type of analysis goes more into the analytical aspects, so to say. It looks at the same price chart as technical analysis, but it also tries to explain why certain variations happen within the chart. Traders using fundamental analysis try to determine and explain the fundamental factors that caused the price and value movements. 

Today, we’ll take a look at technical analysis only. Even if you want to have a more fundamental approach in your trading, knowing the technical one’s basics is still beneficial.

On top of that, beginner traders usually prefer technical analysis as it requires only data comparison skills. 

The Early Days of Technical Analysis

Technical Analysis, as most concepts used to trade on the Forex market, wasn’t invented in the 21st century. There may be people believing that most of the tools they use to trade right now have been created five to ten years ago. That’s not a correct assumption.

For example, technical analysis, as we know it today, was founded back in 1885. Then, the very creator of the Wall Street Journal came up with something known as the Dow Jones Industrial Index

This index took note of Dow’s highs and lows while trading on the market. On top of that, the index-linked those highs and lows with certain events that happened, and that affected the market.

For a more extensive approach, Dow also noted market events that took place in the past. Why? Well, to show that, with enough diligence, they could have been predicted by traders and taken advantage of. Naturally, this prediction would’ve been based on pattern analysis.

The Effectiveness of the Dow Jones Industrial Index

What we mentioned above is a very early stage of what we now know as technical analysis. Dow’s index was properly used later on, by William P. Hamilton. The latter is also the creator of the bearish and bullish trends that can be noticed in the market.

Based on Dow’s index and with the help of some new rules that he created, Hamilton could predict the 1929 crash. Another trader used the same version of Dow’s index and was able to predict the crash of 1932 and its recovery in 1937!

As such, Dow’s index and the rules added by other professional traders are the ideal foundation for technical analysis

The Benefits of Technical Analysis

Before taking a closer look at its core principles, it is worth mentioning the benefits of technical analysis. These benefits also clarify why most traders would be inclined to a technical approach, rather than a fundamental.

forex technical analysis

  • It is an exceptional risk-management tool, as clear data and research are used when determining the trends within the market.
  • It is also highly flexible in terms of analysis. With a good grasp over the principals of technical analysis, traders can apply it to any market. 
  • Moreover, due to how it works on a fundamental level – analyzing present and past events – this type of analysis can be applied to any time frame.
  • Reportedly, trends are easily identifiable by traders that rely on technical analysis.
  • Last but not, traders can use this type of analysis as a standalone. This is because, in most cases, the fundamental analysis does require a tad of technical analysis when researching the market!

The Core Principles of Technical Analysis

Three core principles govern technical analysis. They rule every decision that a technical trader makes on the market, based on the technical analysis they have made beforehand.

1. Market Discounts Everything

The bread and butter of technical analysis are that traders don’t need to analyze anything more than price movements. Such movements are based on the principle in the discussion, which hints at supply and demand basics.

But why only price movements? It would seem normal for traders to analyze interest rate, inflation, and other price-related data as well, right? Well, not exactly, because the asset they trade already has included these values in its price. 

As a result, technical traders don’t have to consider all of the risk factors that they normally would. Price variations and movements already do that!

2. Trends Govern Price Movements

Technical analysis implies that prices will never be accompanied by irregular movement. Instead, they are based on trends with various characteristics – such as long, middle, and short-term ones. 

Long terms last more than four years and come with a couple of peculiarities that we’ll talk about in just a bit. Due to their duration, long terms that experience no price movement in a certain period are likely to see significant price changes soon.

Middle terms usually last between one week and a month, while small terms occur daily. 

3. History Repeats Itself

This is a concept that’s probably as old as time. Given almost any type of event, we can analyze it and predict when it will happen again. The market, while extremely volatile and changing, is highly influenced by this concept.

For example, despite our advancements, the 2020 pandemic came with market occurrences that were very similar to those in 1920. As such, even 100-year-old market charts can still be used today – to predict trends, price movements, and so on. 

You may also like – How to Trade Cryptocurrency in 2020- A Beginner’s Guide

The Three Main Trends of Long-Term Price Movements

As mentioned above, we now look at the three types of trends that govern long-term price movements. They are the ones created by Hamilton – namely the bulling and bearish trend, with the sideways trend.

Any technical trader should know how to read these trends on any given chart:

  • The Bullish Trend – this type of trend implies a downward price movement that is never greater than the upward price movement.
  • The Bearish Trend – in this trend’s case, the upward price movement is constantly exceeded by the downward price movement. Cyclical high and low values characterize it.
  • The Flat (Sideways) Trend – naturally, there’s no price movement in this trend. A flat line on the charts is the main sign of significant price jumps.

Does Technical Analysis Improve Trading Skills?

First of all, as stated above, technical analysis is a great risk-management tool. This is why most traders use it – not because it is necessarily better for them but because it helps them avoid risky trades.

Technical analysis helps traders understand the patterns of the market and, as such, determine what the best course of action is. 

The trader that has mastered technical analysis will be able to analyze charts in such a way that they’ll spot downward and upwards trends. Furthermore, they’ll research any asset (as long as it’s tradable) without requiring any other value than those displayed on the chart.

Reportedly, technical analysis is also ideal for short-term trading. Charts that are twenty minutes long can be easily analyzed and interpreted and can help beginner traders make a wise trade without too much knowledge of the Forex market or other trading strategies.

The Bottom Line

Obviously, technical analysis is only one type of analysis within the Forex market. Moreover, even if we were to add fundamental analysis to the equation, there will still be more than two trading strategies available for any trader.

Each of the two types of analysis can be adapted to almost any kind of strategy and, overall, made personal. However, any strategy will always be governed by the same principles of technical or fundamental analyses. 

It would be wrong to believe that one type of analysis has a higher ground over the other. Both come with various limitations within the market, and, in some cases, one cannot work without the other. For example, technical analysis may not be very useful when the market is facing an unprecedented event!

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