The Fundamentals of Technical Analysis
Technical analysis is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. When applied to foreign exchange markets, technical analysis can help traders and investors identify trends and potential trading opportunities.
Here are some fundamental principles of technical analysis for foreign exchange:
Trends: Trends are one of the most important concepts in technical analysis. A trend is the general direction in which a currency pair is moving. There are three types of trends: uptrend, downtrend, and sideways trend. Traders use various technical indicators to identify trends and their strength.
Support and resistance: Support is a level at which the price of a currency pair is unlikely to fall below. Resistance is a level at which the price of a currency pair is unlikely to rise above. Traders use support and resistance levels to help identify potential buy or sell signals.
Technical indicators: Technical indicators are mathematical calculations based on the price and/or volume of a currency pair. Traders use technical indicators to identify trends, momentum, and potential buy or sell signals. Popular technical indicators include moving averages, relative strength index (RSI), and stochastics.
Chart patterns: Chart patterns are visual representations of price movements on a chart. Traders use chart patterns to identify potential trading opportunities. Some common chart patterns include head and shoulders, double top, and triangles. Time frames: Traders use different time frames to analyze the market. Short-term traders may use hourly or daily charts, while long-term traders may use weekly or monthly charts. The choice of time frame depends on the trader’s trading style and investment goals.
The Fundamental Principles of Technical Analysis are based on the Dow Theory with the following main thesis
- The price is a comprehensive reflection of all the market forces. At any given time, all market information and forces are reflected in the currency prices.
- Price movements are historically repetitive.
- Price movements are trend followers.
- The market has three trends: primary, secondary, and minor.
- The primary trend has three phases: accumulation, run-up/run-down, and distribution. In the accumulation phase the shrewdest traders enter new positions. In the run up/run-down phase, the majority of the market finally “sees” the move and jumps on the bandwagon. Finally, in the distribution phase, the keenest traders take their profits and close their positions while the general trading interest slows down in an overshooting market. The secondary trend is a correction to the primary trend and may retrace one third, one-half or two thirds from the primary trend.
- Volume must confirm the trend.
- Trends exist until their reversals are confirmed. Cycles of currency price change are the propensity for events to repeat themselves at roughly the same time and are an important ground to justify the Dow Theory. Cycle identification is a powerful tool that can be used in both the long and the short term. The longer the term, the more significance a cycle has. The top of the cycle (C) is called the crest and the bottom (T) is known as trough. Analysts measure cycles from trough to trough. Cycles are gauged in terms of amplitude, period, and phase. The amplitude shows the height of the cycle, the period shows the length of the cycle, the phase shows the location of a wave trough.
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