Technical analysis is a method of predicting the future by looking at the past and has long been used in traditional markets such as the stock market. It involves predicting price movements and future market trends by looking at what has actually happened in the market.
Technical analysis is vital to know when trading Forex as it enables you to meaningfully view charts and understand why certain price movements (price action) occurred.
It is based on two key principles:
- Price is paramount. This means that the actual price is a reflection of all known factors that influence this market e.g. Demand, economics and more.
- History does repeat. Technical analysis identifies patterns of market behaviour that are significant and highly likely to repeat. This combined with Forex chart patterns that span more than 100 years back show that human behaviour changes little over time -history will repeat itself.
Charts are the tools of choice when undertaking technical analysis. There are many forms and methods of technical analysis including the use of technical indicators, trend lines, support and resistance lines.
Regardless of the type of method or chart used, technical analysis always relies on reviewing past price movements to forecast future ones. It is best used to find entry/exit points with favourable reward/risk characteristics so you can align your trades with the future currency direction as suggested by the fundamental analysis.
Below is a diagram which helps to distinguish the main difference between fundamental and technical analysis: