Technical analysis (TA) is a method of predicting the future performance of an asset’s price (in our case, the price of a currency pair) on the basis of its historical performance.
In other words, technical analysts study financial charts in order to determine what will happen with the price next.
In contrast to fundamental analysis which is regarding the “value” of the asset, technical analysis is only interested in price, volume and other market information. Some traders use either technical or fundamental analysis, while others combine these two methods to make trading decisions.
TA is based on the Dow theory, which is an approach to chart analysis proposed by Charles Dow (1851–1902), co-founder of Dow Jones and Company and the first editor of The Wall Street Journal. The other great contribution to technical analysis comes from Japan, where a specific type of chart was used for tracking the price of rice since the 1600’s.
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Technical analysis is based on three assumptions
1. The market discounts everything.
Technical analysts think that the price of a financial asset already reflects all the relevant information about it including the various economic factors and market psychology. As a result, to make predictions about the future price it’s only needed to analyze the chart and nothing more.
2. Price moves in trends.
According to technical analysts, the dynamics of a market has a certain rhythm, an order to it. The movement of prices has a bias (upward, downward, or sometimes horizontal) that is called a trend. It’s necessary to analyze the market specifically looking for trends. If there’s a trend, the price will more likely continue moving in line with it rather than change direction. This assumption forms the basis for many trading strategies.
3. History tends to repeat itself.
It is believed that the past movements of the price get reproduced in the present and the future. It happens because traders tend to react to specific things they see on the charts in the same way for psychological and emotional reasons. It’s possible to identify specific patterns and expect that these patterns will occur in the future causing the same price action that they used to provoke in the past. The conclusion is that it’s necessary to study the chart history in order to be able to read the signs of the upcoming price moves.
Technical analysis involves the study of price action as well as the use of technical tools and indicators. The term “price action” refers to movements the price makes. Price action trading means that you take hints on whether to buy or sell based only on the price you see on a chart. Such method suggests that you are not using technical indicators or give them a very little weight in your decision making.
In this section of our educational materials, you will find the most useful and comprehensible information about the TA tools. You will find out more about trends and will learn how to use technical indicators. Understanding of the logics and instruments of TA is a key to successful trading.
Other articles in this section
- Renko chart
- Types of charts
- Heiken Ashi
- Quantitative easing policy
- Pivot Points
- Moving Average
- Williams’ Percent Range (%R)
- Relative Vigor Index (RVI)
- Force index
- Bulls/Bears Power
- Average True Range
- How to trade on central bank decisions?
- CCI (Commodity Channel Index)
- Standard deviation
- Parabolic SAR
- Relative Strength Index
- MACD (Moving Average Convergence/Divergence)
- Bollinger bands
- Trend indicators
- Support and resistance
- Central Banks: policy and effects
- Fundamental factors