A Forex Trader's Best Friend: Technical Analysis

One of the most significant tools available for the forecasting of financial markets is technical analysis, which is the chart study of past behavior of commodity prices in order to forecast their future direction.  Although the ability to use chart analysis has increased greatly over the past decade, it is anything but new.  An enormous number of books and studies have been devoted to this topic alone, and our specific topic, forex technical analysis, has its share of work product that can be studied and used on a daily basis.  Various currency brokers provide excellent tutorials for your education, and software peddlers have developed a plethora of analytical tools for your review and ultimate purchase.

As with any other subject matter as broad as this one, a little bit of background information goes a long way to assist you in your study and provide a compass to guide you in your search.  From an historical perspective, three factors slowly crystallized the thought in traders’ minds that there was a basis for chart analysis.  Accepting price as the ultimate result of all market forces, noticing a repetition of market price behavior, and observing the market tendency to move in trends were the Big Three.  They became the catalysts that enabled the vigorous and continuous effort to refine the process of using technical analysis to profitably predict future market price behavior.

The main strength of technical analysis is its flexibility.  A trader who deals in several currencies but specializes in one may easily apply the same expertise to trading another currency.  A trader who specializes in spot trading can make a smooth transition to dealing currency futures by using chart studies, because the same technical principles apply.  Timeframes may also vary depending on the trader’s primary focus, yet the same principles will still work, as they easily adapt to many points of view.

However, technical analysis is not immune to criticism.  Understanding the nature of negative comments will actually improve your overall appreciation and understanding of what analysis can do for you and where the pitfalls lie.  Random Walk Theory contends that since all information related to forex markets is public, including chart information, then the price already reflects past trends, and its future movement will be random, thus unpredictable.  There have been studies that utilized super computers to refute this theory, but academics still cling to their favorite beliefs.  Lastly, critics posit that technicians only see patterns that they want to see, or in other words, their forecasts are nothing more than self-fulfilling prophecies with little support from reality.  However, chartists rarely create artificial environments ripe for manipulation.  They are merely trying to identify any signals in price behavior that indicate future price activity.

One of the most common phrases that we have all seen, particularly on currency broker websites, is, “Past performance is no guarantee of future results.”  But, can past information really predict the future?  Of course it can!  The process of using past information to produce forecasting models is a strategy that has been followed in nearly every industry on Earth, foreign exchange included.  Markets are cyclical, therefore trends and the ability to predict them are present.  Yes, there is a ton of information to digest, but the downside is not the lack of information.  It is the interpretation of the past, rather than the past itself, that triggers the debate and resulting criticism.  Technical analysis has been proven over and over again in financial markets.  The majority of currency traders use it extensively.

Despite all the technological breakthroughs, charting remains closer to an art form than a science.  Beauty and effectiveness is in the eye of the beholder or creator in this instance.  However, the better at using charts a trader becomes, the more refined his or her forecasting performance.  Today’s tools have improved the task of charting exponentially such that technically inclined traders have only to focus on interpreting them, not on producing them.  Arguments may continue to go back and forth, but the path to success in forex trading remains tied to the ability to forecast price activity in the future by whatever means are at your disposal.

Charts come in a variety of styles and types, some two-dimensional, some even three.  You may not have a Cray computer on your desktop, but you have the ability to detect changing patterns and areas of opportunity with but a few simple keystrokes.  Trends, implied volatility, support and resistance levels, breakout patterns; all will soon join your forex lexicon.  Check out a tutorial, become an avid student, and once you are comfortable with your chart interpretation expertise and realize the benefits in real time, then you may want to move to the next level and check out more professional offerings.  In the meantime, knowledge provides the foundation to exercise judgment, and the exercise of good judgment leads to wisdom, and profits, too!