Technical analysis is one of the two main fields of study of the financial markets. The approach in technical analysis is very different from fundamental analysis.
Technical analysis is the study of price charts and price action. It can be used in tandem with fundamental analysis to gain a complete picture of the markets.
The definition of technical analysis is as follows:
Technical analysis is the study of price action. It works on the principle that price reflects the available information. Therefore technical analysis is the study of past price action to predict future price.
Technical analysts or chartists employ various tools in their study. Most of these tools are either mathematical or linear in nature.
For example, the most popular technical indicator, the moving average is nothing but an average price of the security over a time period.
When price trades above the moving average, it infers that the current price is bullish. Likewise, when price trades below the moving average, it is considered to be bearish.
Types of technical analysis
While the term technical analysis is an umbrella term, there are many different ways within technical analysis.
Regardless of what type of technical analysis you use, they fall into one of these major categories.
- Indicator analysis
- Wave count analysis
- Chart and price pattern analysis
Traders argue about which is the best way to use technical analysis in forex. This is very subjective. Some traders are better trading with indicators, while others prefer to use concepts such as wave counts.
As long as the method of technical analysis that you use in the markets help you to profit, there should be no debate.
Tenets of technical analysis
Technical analysis works on some basic tenets, listed below:
- Price reflects all the fundamentals in the market. The underlying reasons for the price movements are not essential in technical analysis.
- The market moves in repetitive patterns. These patterns are known as trends. Trends are used as signals to govern a technical analyst’s investment or trading strategy.
- The objective of technical analysis is to predict future trends by analyzing past trends and price action.
- Because prices move in predictable ways, technical analysis does not believe in random price fluctuations. As a result, when trends form, it will continue for a certain period.
The debate between fundamental and technical analysis
Proponents of fundamental analysis however discount technical analysis. This is on the basis that fundamental factors drive price action. Therefore, they argue that there is no basis for predicting future price.
This is true to a a certain extent.
For example, technical analysis cannot predict a central bank rising or slashing interest rates. But technical analysis can give an idea about what price can do during the event.
Another example is from the the stock markets where fundamental analysis such as price/earnings ratio, etc. take more precedence than technical analysis.
This depends on how the investor wants to invest. Technical analysis can help you to pick turning points in a trend. But is more often used in short term speculation.
Investing on the basis of fundamentals is more long term and seeks to find whether a security is trading at a premium or a discount.
Why you need a balanced approach
In the context of forex trading, traders argue the pros and cons and debate which is better; fundamental analysis or technical analysis.
Most forex traders put more focus on technical analysis.
Regardless of the debate, the best approach is to make use of a combination of both technical and fundamental analysis. Read more about the various tools available in technical analysis.
A good approach is when you pay attention to the underlying fundamentals and then take a trading decision using technical analysis.
You mean learn that a recent GDP report came out lower than the expectations. Fundamental analysis will tell you that this can impact the central bank’s decision.
Thus, when you know that the price of the currency pair will drop, you can use technical analysis to see a confluence.
But this is not often the case. Sometimes, you will see conflicting signals between fundamental and technical analysis. This is perfectly normal.
At the end of the day, traders need to focus on applying both the concepts as it helps to gain a better perspective of the markets.