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Technical Analysis for Beginners
Submitted by Tradervox on Mon, 18/04/2011 - 18:24
The behavior of currencies in the Forex market can be analyzed by using two major methods - technical analysis and fundamental analysis. Both differ greatly but are very useful forecast tools for the Forex trader. They share the same ultimate goal which is to predict price movement. The technical analyst looks at the effect of market behavior while the fundamentalist looks at the reasons for market movement. Many successful Forex traders use a mixture of the two for the best results.
Forex technical analysis also is a way of predicting the movement of price and the future market trends by the study of charts of past market movement. Forex technical analysis focuses on what has actually happened in the market instead of on what is going to happen. It records the price of currencies and their volume of trade and then creates charts from these information to be used as the primary analysis tool. One of the main advantages of this method of analysis is that experienced traders can follow many currency markets simultaneously.
Forex technical analysis is built on three essential assumptions which are:
1. The Market actions discount everything: This simply says that the actual price of a currency is a direct reflection of all that is known to the currency market that could affect the currency, for example, political factors, supply and demand, and market sentiments. However, the technical analyst is only interested in price movement, not with the causes for the changes.
2. Market Prices tend to move in trends. With technical analysis, patterns of market behavior that have long been recognized as significant can easily be identified. For some of these patterns, the probability of getting the expected result is very high. Also, there are known patterns that keep occurring regularly.
3. History tends to repeat itself. The study of market price data collected over 100 years have identified and recognized patterns that are continuously repeated, which brought the conclusion that the human psychology never really changes over time.
Choosing The Right Trading System
Forex traders use price charts, volume charts, and other mathematical indicators that represent market data to determine the exact entry and exit points for a trade. Some indicators identify trends, while some others help to determine the strength and the sustainability of the trend over time.
Forex technical analysis brings discipline and removes emotion in a traders trading plan. It is worthy to note that in the currency market, there is no perfect system. However, technical analysis helps the trader to organize his trades better and see his trading plan through a more objective and dispassionate perspective.
Some Technical Analysis Indicators that can be used to predict the trend and strength of market trends and movements, to determine the entry and exit points in a trade:
Relative Strength Index (RSI)
This measures the ratio of the volatility of the price (i.e., the up moves and the down moves) and then normalizes the calculations so that it can be expressed in a range of 0 - 100. When the RSI is 70 or greater, then the currency is considered overbought. An RSI of 30 or less is considered as a signal that the currency may be oversold.
This also indicates the regions of overbought and oversold on a currency chart on a scale of 0 - 100%. This indicator depends on the fact that in a strong upward trend, the period closing prices seem to converge in the higher parts of the period's range.
Conversely, as prices fall in a very strong down trend, the closing currency prices tend to near the extreme low of the period's range. The stochastic calculations produce two lines which are %D and %K which are used to show overbought and oversold regions of a chart. The divergence of the two lines plus the price movements of the currency under study gives a very strong trading signal.
Moving Average Convergence Divergence (MACD)
This involves plotting two lines of momentum. The MACD line represents the difference between two exponential moving averages plus the trigger or signal line, which is the exponential moving average of this difference. When the MACD lines and the trigger lines cross, this is considered a signal that the trend is about to reverse.
Forex trading using technical analysis indicators on a Forex chart is a great way to make money and enjoy currency trading success. The trader should essentially see himself as a ship captain. Just as ship captains need their charts to get from point A to point B, a trader needs the indicators on a Forex chart to navigate the perilous waters of currency trading. A good understanding of Forex technical analysis plus learning how to use the right technical indicator at the right time will increase the chance for success in Forex trading.