Technical analysis

technical analysis

Technical analysis mainly consists in analyzing the chart using statistical methods. We simply analyze the past prices and volumes in order to be able to make statistical predictions based on the past but please note that we are analyzing the past and the market is not deterministic! Suppose I have a gun with 10 shots and I shoot a numbered target. Being an experienced shooter (I’m not, I didn’t hold a gun in my hand in my entire life, this is just an example)  know for sure that I can make between 80 and 100 point most of the time. The key words here are “between X and Y” and “most of the time”. So I can’t tell for sure how many points I’m going to score or even if I’m going to score the desired number of points most of the time but what I know almost for sure is that on the long run on average I’m going to score them. The key words here are “almost sure” and “on average”. This is what statistics is in layman terms. And layman terms are the best when it comes to describe a complicated scientific term or process. 🙂 Ok, enough talking, what exactly is technical analysis?

Forex technical analysis is based on the following fundamental assumptions:

1. Forex market is nothing but a reflection of human psychology, that’s why forex indicators work.
I consider this statement to be true. Everything a human does reflects his emotions and his state of mind. Fear, greed, panic, concern, everything is reflected in the way market moves. All factors that influence a price can be seen into the current exchange rate. You can tell that a high impact news just took place just by watching the charts, you don’t even have to read that news! For example, if a very bad news hits the USD, the EURUSD will go up like a rocket. The market is nothing but a reflection of all economical, political, social  and psychological factors so the basic assumption is that we don’t have to read the news or have economical and political knowledge to tell what happens on the chart. We just have to watch the charts, that’s it. We only have 2 factors we should consider, price and volume. Nothing more.

2. History tends to repeat itself
This statement is also true. If you behave one way under a certain situation you have the tendency to have a very similar behavior under a similar circumstance. Same things applies to crowds and forex market is a reflection of a crowd. Well, more or less because there are only a few banks and hedge funds that moves the market consistently (they are also called Smart Money).

3. One thing is certain about the market: it moves, all currencies have the tendency to trend
This is also true because the market is always imbalanced. There is no symmetry when it comes to forex trading!

4. The market can have either trend or range.
The trend can be strong or normal. One of the greatest goals of technical analysis is to anticipate when the market is going to change from trending to ranging and vice versa. One of the most common methods is to draw trend lines which can show the direction and strength of the current trend.

Trending market

Trending market

 

Ranging market

Ranging market

The majors (EURUSD, USDJPY, USDCHF and GBPUSD) have historically shown the tendency of trend while pairs that don’t involve USD and EUR have the tendency to range.
Foes market is the most liquid market in the world, nothing remains the same, it changes almost within seconds and nobody can predict the nature of that change as nobody can predict the future of mankind. Trend traders must never risk more than 2% of their accounts, stop losses should be very tight, no more than 25 pips, even less. Range traders are allowed to use higher stops thus giving time to the market to reach the desired level. Of course, trend traders have confidence that a strong trend follows, while range traders are confident that the market will never break some boundaries. But of course they have to be prepared for failure, that’s why risk management is very important.

5. The market always wins!
This is my favorite statement! Try to fight the market and lose all your money! Don’t use stop loss and start trading based on pure hope that the price will eventually reach your desired level and your account will be blown. Technical analysis is based on winning probabilities not on luck, faith and hope!

6. What goes up must also go down
This is also very true. Let’s consider EURUSD for example. Suppose the pair is trending up. At some point (elliot wave no. 5) no matter how many positive news are coming for the EUR, a retracement takes place. Why? Because there is no apparent reason. The reason is not easy to spot, but please read my very first articles “What is forex market” and “How forex market moves” and you will understand better why does this happens and what happens at overbought and oversold levels.

Indicators

This is not a tutorial about indicators so I won’t get into much details but the most important indicators in technical analysis are moving averages, indicators that measure volatility, fibonacci levels, support and resistance levels. They work not only because they have power by themselves but because we give them power by behaving according to our own predictions. Let’s say a big crowd of people have the power to move the market. Then all believe that once a resistance level is touched, the price will bounce back. The price touches the support level and according to their belief, market movers start to sell the currency. Of course the price will bounce back as the result of their actions, it’s more like a self fulfilling prophecy. More about them into another articles.

How to use technical analysis principles in real live trading?

The market is predictable (more than 50/50) and good trades can be made if you are patient enough and wait for the following sweet spots:
1. After important high impact news (trade the aftermath)
2. Near support and resistance points (trade the reversals or breakouts)

Here is an example of how technical analysis should be performed. Yesterday, Aug 1st, EURUSD fell like a rock, the question is, what to expect this week?

Daily charts look like this:

EURUSD Daily

EURUSD Daily

EURUSD broke the support level and looks like a bearish trend is going to form. I calculated the support level as the last Higher Low. Previous bar closed bellow it suggesting that this might be a turning point. Strong support is to be expected at 1.28000. Hm, interesting, but what happens on weekly chart? Big boys think long term, remember?

 

EURUSD weekly

EURUSD weekly

The weekly chart shows a downtrend as well. So, it’s safe to assume that a new downtrend has just started.

My intraday strategy is to wait for small retracements on lower timeframes (M30) and keep selling.

EURUSD M15

EURUSD M15

 

Short term support can be spotted around 1.32000. I wait until EURUSD reaches near short term resistance lines 1.32231, 1.32391 and 1.32667 then sell. At least this is my plan for today, tomorrow everything may change. I just sold EURUSD at 1.32190 and close the position at 1.32030 for a good profit.

I will start a category called “My trading journal” in which I will post my daily analysis of major pairs just to have you familiarized with technical analysis methods.

Thanks for reading and please share if you like it! 🙂