Back to Basics #1: What is Technical Analysis?

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In financial markets, technical analysis is an analysis technique that uses patterns through the study of past market price to identify trends and market forecasts. Technical analysis represents the most popular approach to market analysis, the second one being fundamental analysis. Neither is necessarily better than the other and both can be effective if used properly.

Technical analysis is based on a scientific discipline called the chaos theory. Even among seemingly random behavior like price movement or even the weather forecast would have past patterns that can be used to forecast future ones.

Going forward, you’re going to learn a couple of the basic principles behind some of the most elementary technical analysis tools available to any trader. Although this is the point that most technicians tend to start out, it’s also the point where a lot of them stay for the rest of their career as one of the most effective ways to analyze the market from a charting perspective.

Technical analysis is the study of price movements over certain periods of time. Price action is essentially the motion or action of a market over time.

What is a chart?

A chart shows price movement over time and can be used to forecast market moves in the future. A chart largely summarizes a lot of the information that we get about what’s going on in the Forex market.

Markets only ever do three things:

  • Move up or uptrend;
  • Move down or downtrend;
  • Sideways or consolidate.

This means that the price action has only two states:

  • Range: here the price generally moves sideways;
  • Trend: where price fluctuates in a general upward direction (a bull trend) or in a general downward direction (a bear trend);

By using technical analysis you can take advantage of trading both the range and the trend. Depending on the price environment, technical analysis can help you learn where to get in and out of the market at the right time. This can be accomplished by using charts.

For example, if your technical analysis tells you EUR/USD is an upward trend, you might predict from this that the price will continue to rise for some time, meaning you might want to buy early in an attempt to maximize potential profits. More importantly, you need to be able to predict when this upward trend will end and start to reverse. It’s at this point you might want to close your position and take profits.

If you buy and sell at the right time you might be able to make a profit. Conversely, though it’s important to note that markets are unpredictable and you might take a loss.

Why is Technical Analysis Important?

On its own technical analysis is not the Holy Grail of trading. Your success will in part be down to good risk management, discipline and the ability to control your emotions. But, technical analysis is important because it can help you better time the market and more importantly it can help you determine when to take profits and place your stop loss.

“Seek the Holy Grail of Trading… At your own peril!”

Thank you for reading!

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At 19, JT was already a stock investor and Forex trader who not only profited from the financial markets, but also managed to pay off his tertiary education in full by putting his investing skills and knowledge to the test. JT firmly believes that investment education is the best form of post-education that accords one the power to attain financial freedom, something that he wants to empower all his students with.

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