The most popular way of forecasting exchange rate movements in the Forex market is technical analysis of price charts trough technical indicators. Traders, who trade solely on the basis of technical analysis, are guided by the postulates of Charles Dow – “price discounts everything”. In a word, the basis for conducting technical analysis is the movement of a price for a certain period of time (opening and closing prices, minimum and maximum), and the fundamental and psychological factors have already been taken into account by the market and are reflected on the price chart. To predict the future behavior of a price, it is sufficient to study its history.
Trend or the direction of price movement on the chart is one of the main concepts of technical analysis. The essence of this concept is that trend moves in the same direction until it gives the signal to reverse. Thus, a trader’s task is to recognize a new trend in the early stages of its formation and enter the market at the right moment in the direction of a trend. The temptation to trade on the corrections against the direction of a trend is extremely great, but this leads mainly to the loss of funds.
There are three types of trend:
- Bullish (upward) trend is formed when demand exceeds supply, and each successive maximum or minimum of prices is higher than the previous ones;
- Bearish (downward) trend is formed when supply exceeds demand, and each new maximum or minimum of prices is lower than the previous ones;
- Flat (side) is formed in case of minor price fluctuations because of low activity and uncertainty in financial markets.
- Methods of technical analysis
- Graphical method is the easiest method of technical analysis. For the prediction of a trend, chart patterns (figures) are analyzed. There are dozens of classic patterns on the basis of which traders forecast the future behavior of prices. Basically, the formation of chart patterns is based on the concepts of support and resistance levels.
- Mathematical method is based on mathematical functions built on the dynamics of a price or volume. They are divided into trend indicators (Moving Average, Bollinger Bands, Parabolic SAR, CCI, Williams Alligator) that show the direction and strength of main trends of the market and forex oscillators (RSI, Stochastic, MACD, Momentum, Ichimoku) that show the reversals of trends.
The history of technical analysis
- Classical technical analysis began to develop at the end of the 19th century, after Charles Dow, the editor and founder of the newspaper “The Wall Street Journal”, published articles and developed a number of principles with the help of which it was possible to make transactions in the stock market without high risks.
- During the Great Depression, American financier Ralph Nelson developed the principles of cyclicity of market waves (fluctuations) on the basis of analysis of stock markets. According to his theory, waves are tend to repeat themselves, which allows not only to specify wave models on the chart, but also to predict the further behavior of prices.
- In the 1930s, the father of scientific technical analysis Richard Schabacker classified chart patterns, developed the theory of gaps, formalized the use of trend lines, the support and resistance levels. With the emergence of computer technologies and development of special programs, there appeared a number of new technical instruments, but the whole technical analysis is mainly based on theories developed in the beginning of the last century.
- Technical analysis of price charts shows that human psychology does not change and models which worked for many years, work today too. In order to predict the future, it is necessary to investigate the past.