It is important to note that, in general, the interpretation of technical analysis remains the same regardless of the asset being monitored. There are literally hundreds of books dedicated to this field of study, but in this tutorial we will only touch on the basics of why technical analysis is such a popular tool in the forex market.

As the specific techniques of technical analysis are discussed in other tutorials, we will focus on the more forex-specific aspects of technical analysis.

Technical Analysis Discounts Everything; Especially in Forex

Minimal Rate Inconsistency
There are many large players in the forex market, such as hedge funds and large banks, that all have advanced computer systems to constantly monitor any inconsistencies between the different currency pairs. Given these programs, it is rare to see any major inconsistency last longer than a matter of seconds. Many traders turn to forex technical analysis because it presumes that all the factors that influence a price -economic, political, social and psychological - have already been factored into the current exchange rate by the market. With so many investors and so much money exchanging hands each day, the trend and flow of capital is what becomes important, rather than attempting to identify a mispriced rate.

Trend or Range
One of the greatest goals of technical traders in the FX market is to determine whether a given pair will trend in a certain direction,or if it will travel sideways and remain range-bound. The most common method to determine these characteristics is to draw trend lines that connect historical levels that have prevented a rate from heading higher or lower. These levels of support and resistance are used by technical traders to determine whether or not the given trend, or lack of trend, will continue.

Generally, the major currency pairs - such as the EUR/USD, USD/JPY, USD/CHF and GBP/USD - have shown the greatest characteristics of trend, while the currency pairs that have historically shown a higher probability of becoming range-bound have been the currency crosses (pairs not involving the U.S. dollar). The two charts below show the strong trending nature of USD/JPY in contrast to the range-bound nature of EUR/CHF. It is important for every trader to be aware of the characteristics of trend and range, because they will not only affect what pairs are traded, but also what type of strategy should be used.

Common Indicators

Technical traders use many different indicators in combination with support and resistance to aid them in predicting the future direction of exchange rates. Again, learning how to interpret various forextechnical indicators is a study unto itself and goes beyond the scope of this forex tutorial. If you wish to learn more about this subject, we suggest you read our technical analysis tutorial.

A few indicators that we feel we should mention, due to their popularity, are: Bollinger Bands, Fibonacci Retracement, Moving Averages, Moving Average Convergence Divergence (MACD) and Stochastics. These technical tools are rarely used by themselves to generate signals, but rather in conjunction with other indicators and chart patterns.

Technical analysis is research of market dynamics that is done mainly with the help of charts and with the purpose of forecasting future price development. Technical analysiscomprises several approaches to the study of price movement which are interconnected in the framework of one harmonious theory. This type of analysis studies the price movement on the market by means of analyzing three market factors: price, volumes, and, in case of study of futures contracts’ market, of an open interest (number of open positions). Of these three factors the primary one for technical analysis is the prices, while the alterations in other factors are studies mainly in order to confirm the correctness of the identified price trend. This technical theory, just like any theory, has its core postulates.

Technical analysts base their research on the following three axioms:

• Market movement considers everything
  This is the most important postulate of technical analysis. It is crucial to understand it in order to grasp rightly the procedures of analysis. The gist of it is that any factor that influences the price of securities, whether economic, political, or psychological, has already been takeninto account and reflected in the price chart. In other words, every price change is accompanied by a change in external factors. The main inference of this premise is the necessity to follow closely the price movements and analyze them. By means of analyzing price charts and multiple other indicators, a technical analyst comes to the point that the market itself shows to her/him the trend it will most likely follow.
  This premise is in conflict with fundamental analysis where the attention is primarily paid to the study of factors, and later on, after the analysis of the factors, to conclusions as to the market trends aremade. Thus, if the demand is higher than the supply, a fundamental analyst will come to the conclusion that the price will grow. Technical analyst, however, makes her/his conclusions in the opposite sequence: since the price has grown, it means the demand is higher than the supply.

• The prices move with the trend
  This assumption is the basis for all methods of technical analysis, as a market that moves in accordance with trends can be analyzed, unlike a chaotic market. The postulate that the price movement is a result of a trend has two effects. The first one implies that the current trend will most likely continue and will not reverse itself, thus, excluding disorderly chaotic movement of the market. The second one implies that the current trend will go on until the opposite trend sets in.

• The history repeats itself
  Technical analysis and studies of market dynamics are closely related to the studies of human psychology. Thus, the graphical price models identified and classified within the last hundred years depict core characteristics of the psychological state of the market. First of all, they show the moods currently prevailing in the market, whether bullish or bearish. Since these models worked in the past, we have reasons to suppose that they will work in the future, for they are based on human psychology which remains almost unchaged over years. We can reword the last postulate — the story repeats itself — in a slightly different way: the key to understanding the future lies in the studies of the past.

Thus technical analysis is another method of forecasting prices. It studies past price action in an attempt to predict the future. The technical analyst focuses exclusively on market information and works on the assumption that all fundamental information is already reflected in the price. Unlike the fundamentalist, the technician attempts to predict future price directions by searching for established patterns of price behavior that have signaled major movements in the past.

Because it is the study of price movement, technical analysis is done primarily through charts.The idea is that a person can look at historical price movements, and, based on the price action, can determine at some level where the price will go. By looking at charts, you can identify trends and patterns which can help you find good trading opportunities. Charts are the major tool in technical analysis. They can help you identify these trends in their earliest stages and therefore provide you with very profitable trading opportunities.