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3 Most Important Technical Analysis Principles for FX Trading

Sep 28, 2018

Technical Analysis is the forecasting of future price movements in financial assets, based on an examination of past price movements.

In the early days of forex, brokers didn’t provide any technical analysis tools on their platforms. Now many offer tools like moving averages, indicators and trend lines, among others. With technical analysis, you can analyze and make informed decisions about the movements of all assets traded with forex, stocks and commodities using price charts and graphic indicators.

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How to Apply Technical Analysis to forex Trading

Because most of the trading in forex is short term and day trading, the main tool for predicating market movements is Technical Analysis.

That’s why it is highly important for every forex trader to understand the basics of technical analysis. This knowledge will enhance the analysis you’re doing and prevent you from making basic mistakes that many traders make.

The original theory of technical analysis introduced these three main principles:

  1. Price discounts everything
  2. Price movements are not totally random
  3. What is happening is more important than Why it is happening

Principle #1

Price discounts everything

It is a premise of technical analysis that current market price reflects the entire information that is available about an asset. The reason is, that the price reflects all the knowledge of all market players. These players may include traders, market strategists, technical analysts, investors, portfolio managers, fundamental analysts and others.

Therefore, the chart is showing us what a lot of smart people and a lot of big money is doing, and that should evidence enough of all the information and opinions.

Principle #2

Price movements are not totally random

Some academics would argue that theoretically, prices move randomly. However, technical analysts strongly disagree. If prices were random, it would be extremely difficult to make money using technical analysis, which is in contrast with the reality, where we find the top Wall Street traders using technical analysis exclusively.

Famous trader and mentor Jack Schwager writes in his book, Schwager on Futures:

“One way of viewing it, is that markets may witness extended periods of random fluctuation, interspersed with shorter periods of nonrandom behavior. The goal of the technical analyst is to identify those periods (i.e. major trends).”

Even though prices move in trends, it doesn’t mean that prices trend all the time. Technical analysts believe that it is possible to identify a trend, trade based on the trend and make money as the trend unfolds. Because technical analysis can be applied to different chart timeframes, it is possible to spot both short-term and long-term trends.

Principle #3

What is happening is more important than Why it is happening

Technical analysts are looking for these two observations: what is the current price and what is the history of the price movement. They are not concerned with why prices have changed the way they did.

There is another school of thought form analyzing markets, which is the Fundamental Analysis. This is popular with stocks and commodities traders, but not so much with forex traders, even if trading is done with forex on stocks and commodities.

Fundamental analysts are mainly concerned with why the price has changed. But the argument against it is that the reasons are too complex. It could be politics, investor’s motives, the economy, or even automated computer trading. It is impossible for any analyst to really know everything.

Therefore, technical analysis believes that it makes much more sense to focus on the “what” and ignore the “why” aspect. So the only questions you should ask yourself are: where is the price now and were was it in the past, relative to this moment?

In conclusion, the price is the end result of the battle between the forces of supply and demand for the asset, which create a non-random movement called a Trend. The objective of technical analysis is to forecast the direction of the future price, by looking at where the price is now and where was it in relation to its current level.

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