As previously in this series we have covered “how we can analyse currencies or forex markets based on fundamental analysis?” Now let’s move on to another important approach of analysing forex or any other financial instrument also known as technical analysis.
What is technical analysis?
Technical analysis is a study used for forecasting the future price movement of any financial instrument by understanding what happened to price previously. In technical analysis primarily price charts of a financial instrument with respect to time are used to observe historical price action carefully. In addition, we may also include volume data in the charts to measure the participation of traders for a given price move. To make it easier to understand for everyone, let’s begin with some question that may be popping up in your mind by now:
Why should I use charts to analyze the markets?
Let’s take an example of a business presentation. Effectiveness of a power point presentation depends on a lot of factors. Now ask yourself, if you want to present complex data in a business presentation, what would you prefer? Would you present the data in figures in a tabular format as it is or give it a colourful, graphical representation?
Undoubtedly, the latter can be understood easily by the audience, despite the complexity in the nature of data. In the same way, in technical analysis we use historical price charts for better observation and understanding of historical price action of any financial instrument.
Is technical analysis is logical?
Despite many advanced techniques used to conduct technical analysis, the main focus always remains on finding out significant demand and supply areas or levels. And we all know how logical the concept of demand and supply is, don’t we? That makes technical analysis a logical approach to analyze the financial markets.
What are supports and resistances?
If you are a trader then you must have heard these terminologies, support and resistance. On a price chart support is an area or a level, where demand can be seen whereas resistance is an area where supply can be seen. For example, if a currency is depreciating against another then significant support price level would be a lower price level where majority of the market participants will consider buying that currency in anticipation of a possible appreciation in future, hence creating demand. In the manner, if a currency is appreciating against another then resistance would be an important price level on the upside where majority of market participants shall consider selling or short selling (in case of derivatives) that currency in anticipation of future depreciation of that particular currency, hence creating a supply. These support and resistance levels can be seen in every price chart of any asset class, be it equity, commodity or currency etc.
What are up-trend and down-trend (bullish and bearish)?
As the name suggests trend is a general direction in which something is developing or changing. In a price chart when a series of higher highs and higher lows is established we can say that the price is in up-trend or bullish. On the other had when a series of lower lows and lower highs is established we can call it a down-trend or bearish trend.
Does it still sound confusing? Okay, let’s break this up further to understand in a better way, if today’s high price of currency pair* is higher than yesterday’s high price and today’s low is also higher than yesterday’s low posted by that particular currency pair, then we can say that price is moving with bullish bias or in uptrend and vice versa for bearish trend or down trend.
(*Note: please refer to our previous articles of this series to know what a currency pair is?)
When to buy when to sell?
Technical analysis is a great tool that can be utilized by all market participants, ranging from day traders to long term investors to recognize the best level to enter and exit in forex market. However, it can certainly provide an edge to investors/traders when used in conjunction with fundamentals, as discussed in our last article of this series. If fundamentally a trader is expecting appreciation in a particular currency and wants to enter long positions, then he can take help of technical analysis to find out the major support level to enter long positions. In the same fashion, short sell positions can be entered near a major resistance level if directionally supported by the fundamentals.
When it comes to forex trading, analyzing the markets is one of the important aspects along with others like risk management and money management for trading. No matter how accurately we forecast the future market movement, for a trader it’s worthless till the time effective risk management and money management is not applied. Therefore we shall talk about how we can apply proper risk and money management to maximise our profits from trading and investing in forex market and currencies.
To be continued…