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The Effects of Technical Analysis on Forex Trading

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In Forex trading two types of analyses exists; technical analysis and fundamental analysis. Fundamental analysis makes use of the economic information which is sourced from different countries while technical analysis on the other hand is based on the analysis of prices, their behavior and movements and also the interpretation of charts. Assuming the past represents or has a bearing on the future then the accuracy of technical analysis can be substantiated. Historical data plays a major role in formulating a forecast for future price patterns and trends.

 

Through the use of graphs, traders can be able to make a choice whether to buy or sell in a given circumstance. On the side of the investors, the interpretation of charts can inform their buying decisions as to whether it is at a fair price or otherwise. Technical analysis happens to be one of the oldest methods for carrying out of a behavioral analysis of the Forex trading market. The graph formation used by technical analysts can take two forms; the form that symbolizes a change in trend such as head and shoulders, double top or double bottom amongst other types. The other form of the graph signifies continuity in the prevailing trend. Formations such as the triangle, pennant and flag are among those announcing continuity.

 

In technical analysis there are three major categories worth mentioning. There is the traditional technical analysis which capitalizes on graphs and charts. With this analysis it is common to see patterns such as head and shoulders dominating the analysis. The second category consists of the contemporary technical analysis which embodies quantitative techniques in its analysis. The use of stochastic indices and moving averages characterize this kind of analysis. The third category is more of psychological than any mathematical verifiable analysis. One of the theories that are synonymous with this kind of analysis is the one advanced by Elliott. In a nut shell, it states that any market movement goes through eight phases which can be broken down into five steps and three market corrections.

 

Technical analysis as a technique in Forex trading draws from a wide range of tactics. For most traders, they would combine them for a wholesome view of the market, its behavior and trends. The principles used by technical analysts revolve around price and its behavior. Its major assumptions which also happen to be the basis for technical arguments are that the price prevailing at any given time is a representation of all the information available in the market at that particular moment. This therefore means that any available market information must be inculcated in the calculation of the price. The price according to technical analysts tends to adopt a cyclic behavior in that historic price movements tend to repeat themselves at a time in the future. Another aspect of price is that it follows a given pattern and the market participants using technical analysis tools can be able to predict with relative certainty the trend to be followed by the price.

 

Pricing in technical analysis can be divided graphically into four groups; the opening price of a period, the last price of a period, minimum price and the maximum price. These periodical prices define the type of graphs that results. Candle stick charts, line charts and bar charts are some of the possible graphs that can capture the price changes over a given time frame. Technical indicators like cyclic indicators, trend indicators, volatility indicators, power indicators, momentum indicators and many others are also frequently used. The grouping of these indicators can be by price, volume, money flow and other criterion. These indicators give an insight into the Forex market and help the trader in the making of sound buy and sell decisions.

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