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Technical analysis is a method of predicting price movements and future market trends by studying charts
of past market action. Technical analysis is concerned with what has actually happened in the market,
rather than what should happen and takes into account the price of instruments and the volume of trading,
and creates charts from that data to use as the primary tool. One major advantage of technical analysis is
that experienced analysts can follow many markets and market instruments simultaneously
Technical analysis is built on three essential principles:
1. Market action discounts everything! This means that the actual price is a reflection of everything that
is known to the market that could affect it, for example, supply and demand, political factors and market
sentiment. However, the pure technical analyst is only concerned with price movements, not with the
reasons for any changes.
2. Prices move in trends Technical analysis is used to identify patterns of market behavior that have long
been recognized as significant. For many given patterns there is a high probability that they will produce
the expected results. Also, there are recognized patterns that repeat themselves on a consistent basis.
3. History repeats itself Forex chart patterns have been recognized and categorized for over 100 years
and the manner in which many patterns are repeated leads to the conclusion that human psychology
changes little over time.
Forex charts are based on market action involving price. There are five categories in Forex technical
Indicators (oscillators, e.g.: Relative Strength Index (RSI)
Number theory (Fibonacci numbers, Gann numbers)
Waves (Elliott wave theory)
Gaps (high-low, open-closing)
Trends (following moving average
Some major technical analysis tools are described below:
Relative Strength Index (RSI):
The RSI measures the ratio of up-moves to down-moves and normalizes the calculation so that the index
is expressed in a range of 0-100. If the RSI is 70 or greater, then the instrument is assumed to be
overbought (a situation in which prices have risen more than market expectations). An RSI of 30 or less is
taken as a signal that the instrument may be oversold (a situation in which prices have fallen more than
the market expectations).
This is used to indicate overbought/oversold conditions on a scale of 0-100%. The indicator is based on
the observation that in a strong up trend, period closing prices tend to concentrate in the higher part of the
period's range. Conversely, as prices fall in a strong down trend, closing prices tend to be near to the
extreme low of the period range. Stochastic calculations produce two lines, %K and %D that are used to
indicate overbought/oversold areas of a chart. Divergence between the stochastic lines and the price
action of the underlying instrument gives a powerful trading signal.
Moving Average Convergence Divergence (MACD):
This indicator involves plotting two momentum lines. The MACD line is the difference between two
exponential moving averages and the signal or trigger line, which is an exponential moving average of the
difference. If the MACD and trigger lines cross, then this is taken as a signal that a change in the trend is
Fibonacci numbers: The Fibonacci number sequence (1,1,2,3,5,8,13,21,34...) is constructed by adding the
first two numbers to arrive at the third. The ratio of any number to the next larger number is 62%, which
is a popular Fibonacci retracement number. The inverse of 62%, which is 38%, is also used as a Fibonacci
W.D. Gann was a stock and a commodity trader working in the '50s who reputedly made over $50 million
in the markets. He made his fortune using methods that he developed for trading instruments based on
relationships between price movement and time, known as time/price equivalents. There is no easy
explanation for Gann's methods, but in essence he used angles in charts to determine support and
resistance areas and predict the times of future trend changes. He also used lines in charts to predict
support and resistance areas.
Elliott wave theory: The Elliott wave theory is an approach to market analysis that is based on repetitive
wave patterns and the Fibonacci number sequence. An ideal Elliott wave patterns shows a five-wave
advance followed by a three-wave decline.
Gaps are spaces left on the bar chart where no trading has taken place. An up gap is formed when the
lowest price on a trading day is higher than the highest high of the previous day. A down gap is formed
when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a
sign of market strength, while a down gap is a sign of market weakness. A breakaway gap is a price gap
that forms on the completion of an important price pattern. It usually signals the beginning of an
important price move. A runaway gap is a price gap that usually occurs around the mid-point of an
important market trend. For that reason, it is also called a measuring gap. An exhaustion gap is a price gap
that occurs at the end of an important trend and signals that the trend is ending.
A trend refers to the direction of prices. Rising peaks and troughs constitute an up trend; falling peaks and
troughs constitute a downtrend that determines the steepness of the current trend. The breaking of a trend
line usually signals a trend reversal. Horizontal peaks and troughs characterize a trading range.
Moving averages are used to smooth price information in order to confirm trends and support and
resistance levels. They are also useful in deciding on a trading strategy, particularly in futures trading or a
market with a strong up or down trend.
The most common technical tools:
Coppock Curve is an investment tool used in technical analysis for predicting bear market lows.
DMI (Directional Movement Indicator) is a popular technical indicator used to determine whether or not
a currency pair is trending.
Unlike the fundamental analyst, the technical analyst is not much concerned with any of the "bigger
picture" factors affecting the market, but concentrates on the activity of that instrument's market.
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