Latest revision as of 23:58, 14 November 2023

Technical Analysis is a method of analyzing a price chart in an attempt to predict where the price of a financial asset will go in the future using past charting data and other technical indicators.

Technical Analysis is a trading discipline employed by some traders, mainly retail traders, to evaluate and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. It typically involves using indicators and oscillators that have gained popularity as trading in financial assets has increased in popularity among retail traders.

In this Wiki, we will examine Technical Analysis primarily from a Forex trading perspective. However, the concepts will be useful in trading most other financial assets as well. We will also draw many comparisons to how a professional institutional trader would approach technical analysis versus how a typical retail trader would.

Trading successfully in the financial markets is not as easy as just knowing one discipline inside and out. This is why Technical Analysis is best used as a timing tool to aid in well thought out Fundamental Analysis, Sentiment Analysis, Price Action Analysis and Trading psychology.

This Wiki is a part of our Essential Forex Trading Guide. Be sure to check that out HERE.

Introduction to Technical Analysis

Technical Analysis is one of the elements of professional Forex trading. The other main elements are Fundamental Analysis, Sentiment Analysis, Risk Management, Price Action Analysis and Trading psychology. We will now spend some time looking at how professional traders approach this Technical Analysis concept in order to give you a good basic grounding. We will expand upon this simple introduction in later sections of this Wiki.

The first point that we would like to make clear about technical analysis is that it’s likely the most simple to understand of all the key concepts just mentioned above. This is because technicals are very visual by nature. There is not a lot of analytical work that needs to be done once you understand what you are looking for.

When viewing technical analysis the focus is on concepts that require no real insight or understanding of the markets when compared to other topics such as fundamentals, psychology, and risk management.

The purpose of this introduction is not to teach you how to use a chart or identify technical patterns. All of these items will be covered in great detail in later sections of this Wiki. The goal of this introduction to technical analysis is to help you understand its role in a professional trading plan.

We will touch on the top methods that are used by institutional traders. We will also highlight just how many retail traders misunderstand these technical concepts to their disadvantage.

One other point that is worth making now is that technical analysis is probably the least important of all the key elements when it comes to Forex trading. This is because institutional traderss will only use them as a reference point to time an entry into a currency pair that they already know they want to be long or short. In this way, we already know what we want to trade before ever looking at a chart.

What is Technical Analysis?

What is Technical Analysis? Technical Analysis takes on many forms and it is a large area of study with many ideas and philosophies. In the following Wiki, we will take a look at the basics of what technical analysis is and how professional traders go about employing them.

You can access the main Wiki What is Technical Analysis? HERE.

Core Concepts of Technical Analysis

Professional traders only ever focus on a few core concepts when it comes to technical analysis. In the following sections, we will go through each of these various methods in a little more detail.

Japanese Candlesticks

Generally, Japanese Candlesticks form the basis of most traders’ technical analysis. A candlestick is something that most people are aware of if they have been exposed to trading so it’s very likely that you already know what candlesticks are but we have a great Wiki to brush up on your Candlestick knowledge HERE.

The concept of Japanese Candlesticks originated in Japan as the name suggests and were used to accumulate great wealth on the rice futures exchanges. They are also very effective at displaying exactly what the price did when it traded at certain levels and give clues as to how the market was feeling at that time.

What we will do now is expand on the concept of Japanese Candlesticks in a separate Wiki because this can be an enormous subject and we want to have a dedicated place for all things Japanese Candlesticks.

In the following Wiki you will learn concepts such as:

CLICK HERE to access the Japanese Candlesticks Wiki.

Previously Traded Price Areas

In the following Wiki, we will explore the concept of Previously Traded Price Areas and how traders use this to trade the financial markets.

You can access the main Wiki on Previously Traded Price Areas HERE.

Price Based Support and Resistance

Another psychological level has to do with the price itself. Oftentimes, certain numbers will get the attention of the market. This can create a powerful psychological level in the minds of the traders watching the particular currency pair.

In the following Wiki on Price Based Support and Resistance we explore:

You can access the main Wili on Price Based Support and Resistance HERE.

Forex Support and Resistance

Now that we have a good grounding in candlesticks that gives us a chart to base our technical analysis on we can now start to form a full picture of what price has been doing in the recent past and see what it’s currently doing in the present in a visual way. The next step to build on this is to look at how those candlesticks can help us to identify key price levels that the market has a high probability chance of reacting to. This is the subject of this section and it’s called Forex Support and Resistance.

We have created a separate Wiki on all things Support and Resistance because it is a large subject area worthy of further study. In the following Wiki ( CLICK HERE) on Forex Support and Resistance we will cover topics such as:

CLICK HERE to access the Forex Support and Resistance Wiki.

Average Daily Range

The next tool that we will look at is the average daily range or ADR for short. In the following Wiki, we will take a look at what the Average Daily Range is and how professional traders use it in their trading.

You can access the main Wiki Average Daily Range HERE.

Moving Averages

Moving averages are a very simple visual charting method that many retail traders add to their charts to help identify the direction a currency is moving.

In the following Wiki, we will take a look at what Moving Averages are and how professional traders use them.

You can access the main Wiki Moving Averages HERE.

Fibonacci

Fibonacci is a concept that has been widely adopted by retail traders across most financial markets. Some professional traders utilize Fibonacci as well and how they use it is the subject of the following Wiki.

You can access the main Wiki Fibonacci HERE.

Technical Analysis Illustration

Technical analysis can be illustrated by imagining a scenario where you are driving your car to a specific destination. Imagine trying to navigate around by only using the rearview mirror that only shows you where you have already been in the past. In certain circumstances, this strategy might work if you were on a really long and straight road with no other traffic. However, as soon as conditions change you would very quickly get into trouble.

In order to have the best chance of success you would need to look forward through the windshield and use the road signs posted to navigate your journey best. This does not guarantee you perfect driving because you will inevitably get lost on occasions, make mistakes, and cause accidents, but your success rate of completing your journey safely would be exponentially higher than if you were just using your rearview mirror.

Trading is much the same. Technicals can be very useful in some scenarios but in the end, you will get in trouble and will fail to reach your destination if you relied upon technicals alone to make all your trading decisions. Looking through the window at the road signs is the equivalent of incorporating the fundamentals and sentiment into your analysis.

The same principle applies to fundamentals. If you only looked forward and never used your rearview mirrors you would also get into trouble from time to time. This would not happen as often, but ultimately you would probably end up having some kind of accident.

What is interesting in this comparison is that the ratio of looking through your front windshield and using your rearview mirrors when driving is actually a perfect illustration of the ratios you should be using when applying fundamental and technical analysis to your trading. The general guide is that your analysis should be split into 20% technicals and 80% on fundamentals, sentiment and risk management in order to be at your optimal performance.

Mechanical systems never work over the long run because the market never moves the same way all the time. When volatility strikes prices can move in a totally irrational manner and the best course of action is to stay out of unpredictable price action rather than blindly trying to carry on trading a price, chart, or pattern-based system. The result will be losses and frustration and a return to trying to find a better system. Hence, this is why the retail trader typically gets locked into a cycle of switching systems constantly because almost none of them will work enough of the time to be consistently profitable over the long run.

Why Retail Traders Focus on Technical Analysis Alone

Having mentioned the previous comments, it is also important to understand why technical analysis seems to be the main focus of every amateur and retail trader in the markets. The reason that technicals do not work the best is that we can quickly prove that wrong by looking at what the professionals or institutional traders do on a daily basis.

institutional and professional traders do not pay thousands of dollars each month for real-time news feeds and professional analysis because they enjoy looking at the news or because they have money to throw away. The reason they pay so much money and put so much focus on those things is because it gives them an edge that other traders who do not have those tools.

The simple reason that retail traders come across technicals when they go on a quest to learn about the markets is that all technicals are marketable and very easy to sell. Technicals are simple to understand and have exactly defined parameters for the strategies. Marketers would have a much harder time getting retail traders to purchase an economics course that then requires you to lease a Bloomberg terminal at $2,000 per month and an upfront commitment of 2 years. The average retail trader doesn’t have access to that kind of money nor the patience to get through understanding the economics of countries to proficiency.

This is the exact reason why retail traderss will always be at a disadvantage when it comes to competing against the institutional players that choose to go the route of trading the underlying economics of a country with the fastest news feed available.

This is also a great time to highlight how valuable these Wikis on Volatility.red are for you to bridge the gap between the retail trader and the institutional players. These Wikis were designed to teach retail traders how to trade like the institutional players but at a significantly reduced cost. We have also gone to great lengths to shortcut the learning process by having you only focus on the things that truly are the reasons behind price movements in the FX markets. Make sure to check out our other essential Wikis that are linked all throughout the body of content in each Wiki.

Many people that gravitate toward trading are basically looking for a way to get rich quickly with no real effort. To make this situation worse many of the people that come to the business of trading are looking for a way to change their financial situation probably because they are not happy with how much money they are currently making or it’s simply not enough to support them and their families. This puts real pressure on new traders which makes it very difficult to get over psychologically and actually focus on the proper things that they need to be doing consistently over time.

On the other side of this thinking, there are people who want to create a product that will appeal to this retail trader mindset in order to make a profit from it. You have to ask what is easier, trying to educate people about news feeds, sentiment, and all the nuances of Central banks and how they affect the markets or showing people a pretty chart that gives simple to interpret signals of when to buy or sell? Really try to understand the point here.

These marketers don’t let the little details like the fact that the system doesn’t work in the real market worry them. The people with the get rich quick mentality want nothing more than to believe it’s true. So in a perverse way, these two groups are a perfect match. This is fundamentally why this whole retail market exists and will continue to prey on these types of people for as long as the markets exist. Human nature doesn’t often change too much, unfortunately.

With all that being said, your technical analysis will still positively impact your trading results if you approach it correctly. It is definitely worth having some knowledge of technicals that you can use to your advantage.

Another important thing to remember is that most technical analysis is the same. If you have a core understanding of certain methods there is very little to gain from expanding your learning beyond that core group of technical concepts.

All technicals are a lagging reflection of what the price has already done and are used by traders to simply get an idea of where the price may trade from again and nothing more. So again, do not become overly focussed on technicals alone.

Forex Price Action Concepts

Forex Price Action Concepts take on many forms. In this Wiki, we will take a look at:

You can access the main Wiki on Forex Price Action Concepts HERE.

=Mistakes Traders make with Technical Analysis

Trading is a difficult business for anyone to attempt. However, there are a few common mistakes that traders make that we can control. In this Wiki, we will explore some common mistakes traders make such as:

You can access the main Wiki for Mistakes Traders make with Technical Analysis HERE.

Top down Analysis Concept

Once you have done your fundamental and Sentiment Analysis you then go to the charts and do something called a top down analysis when performing your technical analysis.

This works by starting from the daily time frame, taking a quick look at the moving averages and where the price is in relation to them. This gives you an idea of where the price is in the bigger fundamental picture and how far it is away from the fair value and the averages.

You then have a quick look at the 4 and 1 hour charts to see if there are any major price levels that could be potential support or resistance that you need to be aware of.

The next step is to drop to the 15 minute chart to find your areas of confluence that could be potential spots to trade from.

The final layer of analysis is to have a quick look at the ADR to see where we are in relation to the average daily range. You can then look for confluence areas with your analysis indicators. If you get a nice confluence zone and the price gets there it might be time to pull the trigger on a trade.

As you can see, technicals can help you strengthen your overall analysis in the markets and provide you with a clear structure for your trading but only in line with the other key concepts such as fundamentals, sentiment, risk management, and Trading psychology.

Related Wikis

Readers of Technical Analysis also viewed:

@@ Line 29: / Line 29: @@
-=='''What is Technical Analysis?'''==
+=='''[[What is Technical Analysis?]]'''==
-When measuring the technicals, analysts and [[Trader_Types | traders]] are simply measuring the movement of the current price from that of the past price.  This pretty much sums up technical analysis and it doesn’t need to get more complicated than that if you don’t want it to.
+What is Technical Analysis? Technical Analysis takes on many forms and it is a large area of study with many ideas and philosophies. In the following Wiki, we will take a look at the basics of what technical analysis is and how professional traders go about employing them.
-Contrary to the popular [[Institutional_and_Retail_Traders#What_is_a_Retail_Trader? | retail trader]] way of thinking, when a [[Institutional_and_Retail_Traders#What_is_an_Institutional_Trader? | professional trader]] looks at the technicals they are not trying to determine which way the price will go next.  Nor will they be trying to predict what the market's next move will be in any way when using technical analysis.  In fact, what they are trying to do is to identify good places at which to enter the currency pair, take their profits, or place their stop loss orders.  They do this because past [[Price_Action_Analysis | price action]] can give us some clues as to where the price might go in the future if we understand why the [[currency]] moved the way it did in the first place.  This might sound a bit contradictory to what we just mentioned but allow us to explain.
-There is a difference in predicting what the price will do next from identifying prices that the market is likely to get to or not get to in the near term future.  When identifying a price to place your stop loss you need to already know which way you expect the currency pair to go.  This means that you need to already have a very good [[Fundamental_Analysis | fundamental]] or [[Sentiment_Analysis | sentiment]] reason for taking the [[Pre-Trade_Considerations | trade]] in the first place.  Your reason will come from your [[Fundamental_Analysis | fundamental]] and [[Sentiment_Analysis | sentiment]] [[Trading_Routine#Step_1:_Research | research]] and will have nothing to do with a technical indicator or anything related to technical analysis.  At least this is how an [[Institutional_and_Retail_Traders#What_is_an_Institutional_Trader? | institutional trader]] would approach it.
+You can access the main Wiki [[What is Technical Analysis?]] [[What is Technical Analysis? | HERE]].
-The larger players are [[trading]] the reasons the [[currency]] is moving.  This means they are doing much more [[Trading_Routine#Analysis_Phase | critical analysis]] than simply saying ''the price has moved here so the technicals say it should move there''.  If there is a strong reason to be long a currency pair then we only want to [[Pre-Trade_Considerations | trade]] long, it shouldn't matter if a [[Chart_Patterns | technical pattern]] or indicator is telling us to be short.
-One of the big issues with [[Institutional_and_Retail_Traders#What_is_a_Retail_Trader? | retail traders]] is that they all tend to search for a [[Technical_Trading_Strategies | technical setup]] before actually knowing what the market is doing, what direction it’s moving, and what the major reason is for the move.  This is in direct contrast to how [[Institutional_and_Retail_Traders#What_is_an_Institutional_Trader? | institutional traders]] approach the markets.  This is the exact reason why almost all [[Institutional_and_Retail_Traders#What_is_a_Retail_Trader? | retail traders]] are constantly taking trades against the [[Fundamental_Analysis | fundamentals]] and [[Sentiment_Analysis | sentiment]].
-Let's take a look at this very [[Japanese_Candlesticks#Bullish_Candlesticks | bullish]] [[trend]] on the 1 [[Forex_Market_Hours | hour]] EURUSD [[Trading_Tools#Charting_Software | chart]] seen below.  For any [[Trader_Types | trader]] looking at this stochastic oscillator, all they are going to see are overbought readings.  This means that any [[Trader_Types | trader]] watching this indicator is only going to be getting [[Trading#Short_Selling | short signals]].  The [[Fundamental_Analysis | fundamentals]] and [[Sentiment_Analysis | sentiment]] are obviously positive because the price has been [[Trends | trending]] higher for days but the only signals that [[Institutional_and_Retail_Traders#What_is_a_Retail_Trader? | retail traders]] are getting are to be going short.  This means they are going to have a lot of [[Trading_Rules_to_Live_By#Cut_Losses | losses]] as the [[Sentiment_Analysis | sentiment]] keeps pushing prices higher.  This begs the question; why wouldn’t you just go long with the [[Sentiment_Analysis | sentiment]] and make some easy [[Futures_Market#Ticks_and_Pips | pips]] rather than trying to fight a beautiful [[Trends | trend]] because some indicator tells you to? [[Trading]] against the reasons that price is doing something doesn't make much sense once you have studied [[Fundamental Analysis]] and [[Sentiment Analysis]].
-https://i.imgur.com/jC4I983.png
-''An image of a very [[Japanese_Candlesticks#Bullish_Candlesticks | bullish]] [[Trends | trend]] on the 1 [[Forex_Market_Hours | hour]] EURUSD [[Trading_Tools#Charting_Software | chart]] showing the stochastic oscillator.''
-This is a problem with a lot of indicators like the stochastic.  You tend to get overbought signals in [[Trends#The_Uptrend | uptrends]] and oversold signals in [[Trends#The_Downtrend | downtrends]].  This means that you are constantly selling when the price is rallying and buying when the price is dropping.  Obviously, this is the exact opposite thing that you want to do but for whatever reasons [[Institutional_and_Retail_Traders#What_is_a_Retail_Trader? | retail traders]] fail to understand this simple fact of most oscillators.  Maybe they will work sometimes in a range bound market but they just don’t work the way that the people teaching technicals would have you believe.
-The fact is that you would be hard-pressed to find a technical indicator that generated an oversold signal that would actually put you in a [[Pre-Trade_Considerations | trade]] that was in [[Trend_Lines | line]] with the real reasons the currency pair is moving.  [[Trading]] with the [[Fundamental_Analysis | fundamentals]] and [[Sentiment_Analysis | sentiment]] will always offer the highest probability for a positive [[Pre-Trade_Considerations | trade]] outcome.
-As an example, suppose that you have done your [[Fundamental Analysis]] and you now believe that the EURUSD will move higher because of something fundamentally positive.  You have an excellent reason for getting into this particular [[Pre-Trade_Considerations | trade]] right now rather than tomorrow or in other [[Forex_Trading_Sessions | upcoming sessions]].  It’s this [[Fundamental_Analysis | fundamental]] and [[Sentiment Analysis]] that has given you the reason for the [[Pre-Trade_Considerations | trade]] in the first place, not technical analysis.
-https://i.imgur.com/JuwBqWG.jpg
-''An image of a EURUSD daily [[Trading_Tools#Charting_Software | chart]] showing a recent [[The_Basic_Cycle#Stage_2:_Rally/Greed | rally]] from a prior low.''
-The next step is to determine where to enter the market and this is where technicals can offer us some value.
-In the same example, you see that that price has recently bottomed and rallied up from a level of [[Supply_and_Demand | support]].  This bounce occurred fairly recently and since then nothing has occurred fundamentally to change your [[Having_an_Edge_in_your_Trading#Unrealistic_Expectations | expectation]] for the pair to [[The_Basic_Cycle#Stage_2:_Rally/Greed | rally]].
-https://i.imgur.com/j12jqqZ.jpg
-''An image of a EURUSD daily [[Trading_Tools#Charting_Software | chart]] showing price moving higher from a [[Support_and_Resistance | support]] area marked by the blue line.''
-You also notice that the pair is currently hovering at recent highs.  This can make it prone to sell off because [[Trader_Types | traders]] will want to take their profits at or before the highs rather than [[risk]] a breakout to fresh highs which may or may not occur.  This is an intelligent area to look to target taking profits.  It makes sense because it was a place where prices sold off previously.
-https://i.imgur.com/tW7apwc.jpg
-''An image of a EURUSD daily [[Trading_Tools#Charting_Software | chart]] at a prior [[Support_and_Resistance | resistance]] level market by the blue line.''
-From looking at the [[Trading_Tools#Charting_Software | chart]] you have now identified two important pieces of information.  First, you have identified that it could be higher [[risk]] to enter a long [[Pre-Trade_Considerations | trade]] at the current price due to where it is in relation to where the price had [[Fundamental_and_Sentiment_Trading_Strategies#How_to_Trade_the_Previous_Session | previously been trading]].  Second, you have identified a very good level of [[Supply_and_Demand | support]] to buy the pair back when [[Trader_Types | traders]] take profits in the short term.  Even though the [[Fundamental_Analysis | fundamentals]] and [[Sentiment_Analysis | sentiment]] may be positive there are times when [[Sentiment_Analysis | sentiment]] will flip to profit taking as [[Trader_Types | traders]] need to ring the register.
-From this simple visual [[Trading_Routine#Analysis_Phase | analysis]] you have avoided a situation where you bought at the highs and would have been forced to sit through some unwanted drawdown.  Then you actually waited for a [[Fundamental_and_Sentiment_Trading_Strategies#Trading_Fundamental_Pullbacks | pullback]] to enter from a price where the market had bought up the pair recently.  This [[Trading_Routine#Analysis_Phase | analysis]] helped to reduce your potential drawdown.  It also helped you a lot with your [[Trading_psychology | trading psychology]] because no one wants to sit through an ugly drawdown or take a stop loss.  You know that the pair should go higher but in the absence of a major catalyst the EURUSD will probably experience a normal profit taking situation before it decides to continue higher.  All of this means you can use a much smaller stop loss, which is one of the aims of [[Risk_Management | risk management]], and ultimately give yourself a much higher level of probability to make a profit on your position.
-Bear in mind that none of that would have ever happened without identifying the [[Fundamental_Analysis | fundamental]] picture first.  Also, remember how much that little bit of technical analysis assisted with that trade.  This is how technical analysis is viewed and approached by [[Institutional_and_Retail_Traders#What_is_an_Institutional_Trader? | institutional traders]].  This is also why technicals can be extremely valuable when used in conjunction with everything else other key [[trading]] concepts such as [[Fundamental_Analysis | fundamentals]] and [[Sentiment_Analysis | sentiment]].  The thing to keep in mind is that technical analysis is not very useful when applied by itself.
-The mistake that so many [[Institutional_and_Retail_Traders#What_is_a_Retail_Trader? | retail traders]] make is not so much using technical analysis, but rather overusing it and trying to get it to replace the function of the more important aspects of [[Forex]] [[trading]] such as [[Fundamental_Analysis | fundamentals]], [[Sentiment_Analysis | sentiment]], [[Trading_psychology | psychology]], and [[Risk_Management | risk management]].  Technical analysis is only one small part of successful [[Forex]] [[trading]].