How does technical analysis work?

Technical analysis of currency movements is now, more than ever, part of the Forex market. As time has passed, different ways of collecting and displaying data have arisen. These differing ways can be taken in isolation to either create or back up a strategy, or can be combined in order to read how the market has arrived at its present point, and how it is likely to move forward. This enables more confident predictions and sounder investments. As time goes on, more data is collected and trends are reinforced. The awareness of a trend allows a more realistic understanding of the market. For someone just starting as a Forex trader, this kind of data is all-important.

One method of technical analysis is looking at diagrams and graphs. Taken over a period of time, this allows us to define and explain a pattern. One of the most popular styles of graph is the “Candlestick pattern”, which tells at a glance for any given day where the price was at the start of a period, at the end of the same period, and its highs and lows in the intervening time. Thus you can see at a glance if a currency is genuinely rising fast or slow, or falling at the same rate. The use of Fibonacci figures is another popular analytical tool. It looks at certain points in the rise or fall of a market and – with incredible regularity – predicts when it will stabilise or “retrace” (this means reversing its trend).

Forecasting forex rates is an acquired skill

It’s not easy to forecast the forex markets, but it’s what many forex traders and brokers do every day, with varying degrees of success. Like forecasting the weather, predicting the forex market is sometimes subjective, sometimes a guessing game if you don’t know how, but there is a science behind forecasting the rates which is worth your time to master.

Two major methods used to forecast the behaviour of the forex market are Technical Analysis and Fundamental Analysis which are useful forecasting tools for forex traders. Let’s look at them both.

Technical Analysis studies the effects by predicting price movements and future trends by studying what has happened in the past using charts. It is concerned with what actually happens in the market.
In other words, it examines past market action and uses that data to predict the future. Past trends in most areas of life are almost always good indicators of the future; and forex is no different.

Since forex rates change constantly throughout the day, every day, looking at all the years of past data can be daunting. Smart analysts learned to look at the big picture, to skip the minor details and examine trends over a longer period of time.

Using fundamental analysis to forecast forex markets is a bit more in-depth, but it can also be highly accurate. Basically, fundamental analysis means forecasting the market based on external factors — political moves, government involvement, social movements, even the weather. Someone good at fundamental analysis might forecast forex drop-offs because he knows a country’s government is unstable at the moment, or increases because the country has just elected a popular new leader. Anything that can affect a nation’s economy can affect the exchange rates, and that’s what a fundamental analyst uses to guess at the forex market’s future

Naturally, this means having to know a particular country in-depth, which is hard to do for more than a few countries at a time. (It becomes even more complicated when trying to forecast the euro, since several different countries use that currency.) But having that kind of intricate knowledge makes it much, much easier to forecast forex trends.

Most good forex traders use a combination of both techniques, technical and fundamental. For example, a trader might see that a country is currently facing a particularly strong unemployment rates (fundamental) and know that in the past, strong unemployment rates have meant a weaker economy for that nation (technical). Thus, he can predict down-turns for that nation with some degree of confidence.