Monday, February 8, 2010

INTRODUCTION TO TECHNICAL ANALYSIS

What is Technical Analysis?


"Technical analysis" sounds much more complicated than the actual process is. It could be referred to as "price analysis", as this might be a more accurate description. Through the use of charted data, traders around the world analyze their market of choice. The objective: to try and determine future price movement. To the technical analyst, this means understanding price movement patterns of the past.


The charting of price movements illustrates a visual tug-of-war between buyers and sellers. Notice how price patterns formed on the following chart tend to repeat; technical traders attempt to identify patterns of these nature, and base their trades accordingly.


Does Technical Analysis Work?


Analyzing price patterns is actually very similar to analyzing human behavior. While humans can at times be unpredictable in nature, humans are typically considered to be creatures of habit. The average human adheres to certain paradigms. If one were to observe an average person's daily routine before leaving the house for work their behavior may seem random or without purpose.


However, if one were to observe the same human day after day, within a relatively short amount of time it would not be hard to outline that person's morning routine. In fact, nine times out of ten you would probably be able to predict with impressive accuracy how your observed creature would prepare for their day, perhaps even down to the minute.


The Forex market is sometimes considered a creature of habit. Analyzing price movement can be effective because the past can teach us how the market will react to certain situations. History has shown to repeat itself. Technical analysis offers traders a certain level of expectancy when considering future price movements. There is no crystal ball for predicting the future of the market, though there are keys to understanding patterns, past, present and future in the that traders have developed over time.


Does Technical Analysis Fail?


Technical analysis can fail when traders fail to consider the fundamentals. Fundamental factors such as political events, a hike in interest rates, unemployment rates and so on will impact the Forex market more substantially than perhaps any other market. Fundamental factors often drive major price movements. A trader focused on technical analysis cannot ignore Nonfarm Payroll on the first Friday of the month and expect his or her technical indications to be as accurate as the day prior. Notice the price movement shown in figure 2. Shortly after the Nonfarm Payroll announcements, price reactions were wild; during such times technical analysis may not be able to be counted on. Purely technical traders understand that certain political factors throw all other price forecasts out the window.


Forex Risk


There is considerable exposure to risk in any currency exchange (forex) transaction. Any transaction involving currencies involves risks including, but not limited to, the potential for changing political and/or economic conditions that may substantially affect the price or liquidity of a particular currency.

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