Over the years, Forex trading has become increasingly popular. With the advent of new technology and the accessibility to technical analysis and information on how to invest, more and more people are trying their hand at online trading. However, the market can be extremely tricky to navigate, especially for newbies. Some publications say that as much as 90% of traders give up on trading after losing their hard-earned money.
The trick to consistently siphon money from the market is to equip yourself with tools that can allow you to study trends and make the most educated trades. Contrary to what it may seem, trading is neither a game of chance nor is it gambling: the most successful traders know this and are consistently striving to stay a step ahead of the market. And that’s where technical analysis comes in.
What is Technical Analysis?
Simply put, technical analysis is a set of tools that allows a trader to study how an asset’s price has moved in the past. It also helps them to spot patterns that can help them predict how the price will behave in the future. The assets’ past behavior is called a historical price movement, and the set of techniques used to study them and find patterns are reliant on a few assumptions:
- An asset’s price moves on trends
- It discounts all available information
- History repeats itself
Essentially, technical analysis allows traders to make educated guesses about ‘when’ they should place a trade. Most traders couple technical analysis with fundamental analysis, which shows you ‘why’ it is the best time to open a trade by looking at economic and sociopolitical considerations affecting the asset’s demand and supply in the market as well as the risk factors that influence its price. With these tools, you will be able to study the market and trade, confident that your investment will have a higher chance of paying off.
How Does Technical Analysis Work?
With technical analysis, traders strive to identify the support and resistance levels of an assets price. In fact, these two terms are the bread and butter of all kinds of trading and allows traders to predict the best times to either buy or sell an asset.
Let’s have a more in-depth look:
An asset’s price movements are recorded on charts. In the old days this meant actual charts but these days, most traders use computers and apps on mobile phones. Price action, which refers to price movements, has two states that are referred to as the ‘range’ or the ‘trend’. The range is when the price zig zags sideways across the chart while a trend is when the price zig-zags up or down the chart.
When the asset price trends upward (uptrend), the highest point it reaches before zigzagging down is called the resistance. Conversely, the lowest point an asset price reaches as it trends downward (downtrend) before it starts zig-zagging up the chart is called the support. Resistance indicates that the asset is in high demand and there are a lot of sellers disposing of it, meaning this would be the appropriate time to sell. Support, on the other hand, means supply is high, and this would be the suitable time to buy the asset before it reaches its highest point and starts down-trending.
Popular Technical Analysis Methods
Now that we know what technical analysis is and how it can help you decide when to buy or sell an asset, let’s look at some of the most popular technical analysis methods among traders. These are the most common techniques used by traders to develop and execute their short and especially long-term trading strategies.
A wedge pattern refers to a price pattern that has converging trend lines on a price chart. To get a wedge pattern, you will draw two trend lines connecting the highs and lows of an asset’s price over 10 to 50 periods. As such, wedge patterns can either be bullish (trending up) or bearish (trending down) depending on how the price series within the wedge trends over time. Most traders who are well versed in technical analysis use wedges to work out potential reversal price action.
Bollinger Bands are one of the most popular tools of technical analysis as they are a pretty good measure of an asset prince’s volatility and are useful at determining a trade’s entry and exit points. Simply put, this technical analysis tool consists of chart overlays that envelopes a price’s moving average with two lines. Two standard deviation lines are drawn above and below the simple moving average.
As the price on the chart gets closer to the upper band, the more overbought the market is considered and it is due for a pullback drop in price. As it moves closer to the lower band, the more oversold the market is considered and prices are expected to bounce back.
High-Risk Investment Warning: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial adviser if you have any doubts.