Technical analysis in Forex trading

Technical analysis in Forex trading
by Olivier Becquet

TECHNICAL ANALYSIS

Involves the review of previous prices in order to be able to predict future prices. Technical analyst concentrate only on the exchange rate between two currencies, because they are of the opinion that it represents the true state of the market at any point in time. Price chats are used to arrange price fluctuation into patterns that can easily be recognized. Candlestick represents the fundamental price pattern which often used for technical analysis. A single candlestick represents a summary of all trading decisions by all forex traders during the period the candlestick was being developed. There are different reasons that guide the decisions taken during the formation of a candlestick, however, what is of paramount importance is that the net outcome is recorded in an open, close, high and low of a candlestick.

The connection between the different levels show the comparative strength of bullish or bearish opinions within the market players who transacted during the candlestick period. A number of candlestick come together to form intricate price patterns which show the way the market fluctuates between different levels of bearish and bullish opinions. By taking a look at these price patterns, the technical analyst looks to understand the total emotional mind set of the market players and tries to profit of their emotions. Being able to profit from such form of analysis is very much a possibility as general trader psychology is guided by precise rules of development which can be measured objectively. Technical analysis offers a collection of tools, gotten from these specific rules of development that allow forex traders to measure objectively the different areas of general area psychology without being swayed by the evolving emotional mind set of the majority. Due to the fact that the forex market represents the biggest market worldwide and as a result reflect correctly the rules guiding large investor behaviour, applying the rules systematically when trading in forex can lead to major profits.

To quote John Percival in his book titled “The Way of the Dollar”, 

Price extremes coincide with extremes of sentiment, which can vary from euphoria to revulsion.

Technical analysis can be used to make money from the emotional excesses of other traders in the forex market. Technical analysis makes use of tools such as moving averages and trendlines to evaluate existing market sentiment, this is commonly referred to as the trend. Trends consists of changing times of rising bearish and bullish sentiments. During uptrends, bullish sentiments tends to be on the increase compared to bearish sentiment. This leads to prices increases (typically referred to as price thrusts) and lower counter-trend price falls (referred to as price reactions).

While during downtrends, bearish sentiments usually rises a lot stronger than bullish sentiments this leads to stronger price decreases and lower counter-trend price increases.

A Technical analyst makes use of different techniques such as (Fibonacci retracement, indicators, Bollinger bands, pullbacks to trend lines, and so on) to figure out the conclusion or collapse of a price response and makes its entry into the market when the corresponding price thrust begins.  He exits the market when the price thrust has been over-stretched (i.e. when the existing sentiment has reached its peaked and is no longer sustainable). There are different tools which you can use to know when these conditions occur, they include, indicator divergencies, trend line breakdowns, price channel projections, and reversal price patterns. By being able to enter the market at the beginning of price thrusts and exiting at the end of the thrust, the technical analyst makes maximum gains from the market due to existing sentiments. Being able to maximise your gains from price thrusts allows you to profit from impulsive traders. Different tools can be used to analyse simultaneously the sentiments that are prevalent in the forex market, a technical analyst can find the price levels for currencies with high chances in a shift in due to sentiments. The chance of a shift in sentiment increases when different totally unrelated tools reflect the undercurrent of large investor psychology. This tends to portray the emotional mind set of the market as unsustainable

According to Linda Bradford Raschke, 

Emotions drive the markets to extremes, and these extremes are the ideal spot to exit our trades.

It is also important to note that Elliott wave analysis group all the prize fluctuation of all currencies into 2 categories of waves which are dependent on whether they are in line with the existing market sentiments (impulse waves) or they are against it (corrective waves). In order to account for each market movement, the Elliot wave principle comprises of wave personality which is a reflection of the nature of large investor psychology at the back each wave type that is formed.

Different from fundament analysis, technical analysis allows you to correctly time your choice in whether to make an entry or an exit during trading. This allows you to maximize your rewards and minimize your risk. Technical analysis allows one to be able to correctly find the best holding period for you. Having knowledge of the level of trend in which you are operating in ensures you focus on unique types of resistance and support from which you could either exit or enter your spot.

Technical analysis also allows you to take advantage of too much emotions amongst other forex traders. Consequently, if you intend to benefit from this study, it is highly advisable that you do not get emotionally attached to development that occur in the market. The best way to go about this is to develop your personal forex trading plan before you begin to purchase and sell currencies in the market. It is also important you follow this plan to the letter once trading has begun. Having a plan ensure you do not get emotionally attached and impulses as a result of fear and greed do not overcome you. A lack of plan means you might lose focus.

According to Alexander Elder, 

Sirens were sea creatures of Greek myths who sang so beautifully that sailors jumped overboard and drowned. When Odysseus wanted to hear the Sirens’ songs, he ordered his men to tie him to the mast and to put wax in their own ears. Odysseus heard the Sirens’ song but survived because he could not jump. You ensure your survival as a trader when on a clear day you tie yourself to the mast of a trading plan and money management rules.

A technical analysis of the forex market can also be compared to the job of a therapist who is trying to figure out his patient’s consistent mood swings (in this case the technical analyst is the therapist while the market is the mood swings). It could be said the real-life experiences of the patient is the primary cause of the patients state, most patients are controlled  by what he/she sees in his mind, how he translate these experiences and the way he reacts to them. When humans are faced with familiar situations in life, they tend to react the same way they did when the situation occurred in the past. This improves their ability to interpret such experiences.

In line with the assumption above, a detailed technical analysis should be focused on allowing the market expression its feelings to you while you do not get emotionally involved with the feelings, this leaves you with the ability to remain objective. It entails being able to read the signs you receive from the market about an existing sentiment and responding when the signal is enough for you to respond.

It is very easy to allow emotions control you either due to fear or greed while trading in the forex market, this consequence being your chances of success are significantly reduced. In order to prevent such from occurring, it is best you make use of technical analysis and ensure you are very organized and stick to the plan.

The first step involves picking the right technical analysis tool for you. Your choice of tool can be based on the tool currently being used in the forex trading community you find yourself. You can get this information from investment banks or books on forex.

The second step then involves you making use of your selected tool to build and develop your own trading system which will serve as a guide in your forex trade.

Lastly, you have to be able to put your emotions in check, and build the level of discipline required for you to take the right decisions at the time you need to.