Lesson 6 – The Basics of Technical Analysis

Gaining success in Forex trading (also true for other finance spheres) is impossible without thorough analyses. A trader should know how to determine the phase of a market at a given moment and its possible direction in order to choose the optimal trade at that moment.

Technical analysis helps to answer these questions and to make the appropriate decision. The history of technical analysis began more than a hundred years ago; however, until trading was spread through the Internet, only a few specialists were interested in it. Today, technical analysis is the most widely applied way to determine price changes.

The goal of technical analysis is not to forecast the future. Nobody can predict what is going to happen tomorrow—well unless you are a clairvoyant like Nostradamus or Baba Vanga. And it is highly unlikely that even they could forecast the exchange rate. Therefore, if you think that you will learn the basics of technical analysis, as taught at the university, and you will start earning lots of money, then please understand this is not going to happen.

Technical analysis is the base of the instruments that are offered to traders. And a trader is choosing them in accordance with his preferences and trading strategy.

Basics of Technical Analysis

The price movement is determined by trends. The main point is to recognize those trends early on and trade in accordance with them. Of course, there are strategies to trade against a trend; however, those strategies are more risky and should be used only by more advanced traders.

There are three types of trends:

1) An increasing “Bull” trend: the price is going up. It is called “Bull” because a bull is attacking upwards with its horns up. Most strategies are dedicated to following the bull trend; however, such strong trends do not occur every day.

Bull Trend

2) A falling “Bear” trend: the price is going down. It is called a “Bear” trend because the bear attacks in a downwards motion.

 

Bear Trend

3) “Sideways” trend (flat or horizontal movement): a market is calm, there is practically no movement. Traders who are using trend strategy lose their money at the time of sideways movement because the price is neither increasing or decreasing, and at the end we can see what looks like a channel in the chart. Therefore, Stop-Losses are most frequently triggered because most traders placed their SL near the border of the channel, and the price is going back to be within the channel. However, a lot of strategies are designed to work exactly in this situation: you would buy when the price is below the channel and sell when the price is in the top part of the channel.

Sideways movement, flat

It is important to note that the price is rarely moving in a straight line. In reality, the price is always fluctuating and jumping in a zig-zag manner. A “Bull” and “Bear” fight is happening here. If price maximums and minimums are following each other at the same pace, we can see the price moving within a channel in a chart. When plotting the channel, we can trade from its limits in accordance with the rising trend.

Price movements in the channel

Methods of technical analysis

When we see what kind of trend is prevailing, we can examine the situation in great detail. The methods of technical analysis are divided into the following categories:

1. Graphics method. Graphical patterns are used, such as bars, lines, figures, Japanese candles, pivots, horizontal levels (such a levels of support and resistance), and the whole Price–Action setups. In essence, the main function of these patterns is to estimate the trend. The patterns can indicate that a trend is staying the same, warn that a trend is changing or show that a market has not yet decided further movement. When we are familiar with graphical patterns, it is not difficult to say what to expect—but it is hard to say when it is going to happen.
2. Filters.There are additional instruments that filter the main data. Usually, these are indicators based on mathematical algorithms. These include Moving Averages and various oscillators. A lot of them can be found in MetaTrader 4. We will discuss them in more detail in a later lesson.
3. Cycle theories.These theories describe price movements in cycles. Some cycles are based on mathematical algorithms, some are financial, and some are based on personal philosophies (e.g. the Elliot Wave Theory). There are a lot of theories, some of which are based on sun activity, the magnetic polarities of Earth, or planet movement.

Usually, people combine different approaches instead of following just one. All trading strategies have one basis—for example, the Price Action method—and use additional filters. There is no best or worst method; one method is more suitable for one trader than for another.

Technical analysis consists a very wide spectrum of instruments that you can choose from when deciding on a trading strategy; therefore, you need to know the basics of technical analysis.

Exercises

1. In MT 4, please open the EUR/USD chart and set the time-frame to H1. Try to find the history and draw

• 5 bull trend lines
• 5 bear trend lines
• 5 channels

2. In MT4, please open the EUR/USD chart and set the time-frame to H1. What trends were prominent over the past few days? Please do the same for USD/JPY, AUD/USD, USD/CAD, and GBP/JPY.

I wish you success!

Do you have any questions? Please write your questions in the comments section—we will do our best to solve them with you!