Understanding the Basics of Technical Analysis

There are two major methods used nowadays to predict or forecast the behavior of the Forex market. Technical analysis is one of the two tools or methods. Understanding what technical analysis points to and what it is concerned with will greatly enhance decision-making when trying to spot buy or sell signals.

The aim of the approach of technical analysis is to support a trader or investor to determine forecasts or views into the exchange rates of currency pairs. The method in which technical analysis employs to predict price movements and future trends is through studying what has actually happened in the past. It is concerned primarily on previous market behavior with the premise that history will repeat itself.

Being concerned with previous trends technical analysis takes into account the price of instruments. It is also concerned with the volume of trade. Its primary tool therefore is the charts from the data that has been accumulated. It is a study of price changes and price fluctuations.

Here are some underlying principles behind this approach.

Prices reflect all information that will affect market price. In technical analysis the price connotes the value of all market participants. It even reflects the participant's psychology. The actual price then becomes a reflection of all that is known that could affect market price. Inflation, interest rates, supply and demand, political factors, and even market sentiment provide trends that would reflect the market price.

We then need only be concerned with the price movement not so much on the reasons for the changes. It is assumed in technical analysis that the market is an extremely efficient mechanism. And it discounts or absorbs all things that affect price.

In technical analysis it is believed that prices move trends and create patterns. Significant patterns of market behavior require identification. If we are able to identify the long recognized significant patterns there is a high probability that they will produce the same expected results.

By mapping or charting price movement we may recognize these patterns or trends and be able to predict market behavior. The information about a financial instrument and its future direction will be reflected trending in an up or down, or a sideways pattern

The third underlying principle behind technical analysis is that history does tend to repeat itself. Chart patterns have been recognized over the years. These patterns lead to a conclusion that human psychology has changed only a little. And in conclusion it is safe to assume that since the patterns have indeed worked in the past it is very likely that they will work again in the future.

An example would be that if there were a major sell off at certain price levels, it may happen again when these price levels are reached (which are priced under supply and demand forces) as affected by the need for either supply or demand.

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