Technical
analysis is studying past pricing in order to make a statement about the future
on that basis. Many forex strategy is based on obtaining forex information
using technical analysis. Some traders do not even look at forex charts
anymore, only to technical indicators like Moving Averages or the Relative
Strength Index (RSI). More information about technical indicators can be found
on the forex strategy page.
The Bulls & the Bears
Currency
trading is about predicting the market. No trader is always right, but the
successful trader knows how to keep his losing trades within limits and
maximize his winning trades. This is the core of successful trading on the
forex market.
In order to
maximize the chance of a correct prediction, the trader has two analytical
tools: the fundamental and the technical analysis, the analysis of the news and
the analysis of price behavior in the past. However, both instruments are
governed by the same all-determining factor: man.
Because
the prices on the currency market come about through human behavior. By the
outcome of the battle between one group (that bet on decline) and the other
group (that bet on rise). Or:
Total effort Group A> total stake
Group B = prize goes towards group A expectation.
In
currency trading these two groups are often called Bulls and Bears.
Bulls: Traders who bet on the increase of the base
currency against the quote currency. So for the EUR / USD currency pair, for
example, they take a long position (buying euros / selling dollars).
Bears: Traders who bet on the fall of the base currency
against the quote currency. In the example above they therefore take a short
position (selling euros / dollars purchases).
It is the eternal battle between the bulls and the bears
that determines the price changes. Prices do not come about through news
reports, government decisions or movements of graphs, they come about through
the reactions of the participants to the forex market. This insight is half of
the war.
The cause of price behavior on
the forex market
Price behavior is not entirely logical, but also not
entirely illogical. If prices were to develop perfectly logically, everyone
would always agree - logic does not leave room for different outcomes. But if
price behavior was completely illogical, then there would be no arrow on the
price development of currencies. And that is certainly not the case. because
people-at least for a part-rational beings who make rational considerations.
A large part of the price changes is achieved by:
1) Responses based on economic reality (multinationals
& governments)
2) Expectations based on fundamentals (traders)
3) Expectations based on technical indicators (traders)
4) Parabolic scaling (dealers)
Reactions based on economic
reality (multinationals & governments)
Multinationals hedge their economic risk because of
activities abroad. hedging means taking two opposing positions to reduce the
risk). However, they do not act on possible price changes but on the actual
situation on the market, in comparison with their own economic activities.
Governments sometimes take positions on the forex market
to try to steer the course in a certain direction. This happens less than
before (the market has actually become too big), but it still occurs. For
example, in 2008 the South Korean government announced that it would sell 5
billion dollars to boost the price of the Won.
Expectations based on
fundamentals (traders)
News that affects the GDP, the interest rate, the trade
balance or the political situation of a country also affects the forex market.
Traders try to predict what the expectations are based on the news, so that
they can respond to it and take a favorable position.
Expectations based on technical
indicators (traders)
Technical instruments to 'read' the market have become
increasingly important in recent years. This is also because these instruments
are increasingly easier to obtain and use for the millions of new amateur
traders that have been added by the rise of the internet. These indicators are
the focus of the upcoming articles.
Parabolic scaling (dealers)
This sounds more complicated than it is, but translation
is difficult. Later on it is discussed more extensively, but what it comes down
to in short is that the dealers are by definition on the wrong side of the line
in a strongly moving market. For example, if everyone wants to buy Euros and
sell dollars, they have to sell Euros and buy dollars. Otherwise, no
transactions can be concluded.
They reduce the risk of this by taking larger positions
as the price continues to develop in a certain direction. This 'Double up'
strategy is called parabolic scaling. The effect is that they break even more
quickly when the price moves in the other direction. The result, and that's why
we call it here, is that natural resistence & support levels form at the
points where the dealers break out.
Parabolic scaling is, among other things, an important
reason for the strength of the Fibonacci lines used by many forex traders.
Identify and assess price
behavior: Technical Analysis
Technical analysts look at price behavior in the past and
try to make statements about the future on that basis. Because even though
there are inscrutable movements in every price development, a lot of price
behavior turns out to be recurring; in other words, there are patterns in it.
Some of these patterns can already be seen by simply
plotting day prices on an xy axis. For example, for each trading day, enter the
'closing price' (which is not really the week after, because the currency trade
runs 24 per day) in the Netherlands (16.00 in the afternoon) for the EUR / USD
and see how the price is develops for a few months.
See for example the price development of the EUR / USD
from 2006 to June 2008.
There is clearly an upward trend. Long-term breakthroughs
are not very common, so simple reasoned for a long-term trader is safer to take
a long position EUR / USD (ie buy Euro, sell Dollars) or follow the trend. This
is indeed (considerably) simplified, but it shows that looking at price
developments can provide valuable information for taking profitable positions.
Technical analysts look at the development of the price
in many different ways. Roughly, however, there are 3 ways to distinguish:
1) The
development of the price over time (so 'simple' charting of prices)
2) The
development of the development of the price. Many of the
best / most used technical indicators are so-called 'derivative' indicators:
They look at the development development. An important reason for their
popularity is that they 'fake developments' easily get out of it and thus give
a clearer picture of the market situation. There are also indicators that look
at the development of the development of price developments. :) (derivatives
derivatives); reminds me of poker, where you have to learn to think what your opponent
thinks you think he thinks about your hand.
3) Different
time units. How the course has evolved over the past hour can give a
completely different picture than how it was over the past 24 hours or 30 days.
Analysts look at different time units, which also differ from the time they
acted on (intraday, day, short, etc)
A judgment about the market supported by fundamental
indicators and technical indicators has a much greater chance of success - and
therefore on profit. The players in the (forex) market have in recent years
increasingly orientated themselves on technical indicators, which means that
part of the price development also becomes a self full-filling prophecy -
everyone responds in a certain way to a development because everyone knows the
prediction of the same indicators. For that reason alone it is very important
to know how technical analysis is developed and what kind of indicators are
used.
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