The foreign exchange market uses two different ways to predict the movement of prices and to make purchases that will ultimately allow traders to make a profit. One way is to use fundamental analysis. A second, more popular method is technical analysis. Free online charts and tools are becoming increasingly more available. This allows traders to look at previous trends with the hope that past trends will help establish the movement of prices in the future.
Advantages of Technical Analysis
Technical analysis ignores all external factors, including the social, political, and economic state when looking at prices. It is assumed that these factors have already impacted the current rate of exchange so it’s not necessary to analyze these independently. Despite the fact that dissimilar currency pairs are being monitored, technical analysis results in fewer inconsistencies. The stream of resources and the action of individuals participating in the market has the largest impact upon the change in currency values because of all of the investors who are taking part in currency trading.
Tools and Indicators used in Technical Analysis
Technical analysis attempts to establish if a pair of currencies will maintain the trend of either increasing or decreasing, whether it might reverse direction, or whether it might travel sideways. It also can determine if a currency pair will remain in its high-low range. There are a variety of gauges used in technical analysis, including support and resistance levels. Technical Analysis also uses volatility based indicators, ranging indicators, an indication of moving averages and indications of volume. These can all be used in the Foreign Exchange Market to make a profit.
1. Moving average based indicators (also known as MACD) can be used to determine whether or not the value of currencies are trending. This indicator can be used in divergence trading. It also has a signal line which can be used to notify traders about the right time to purchase or get rid of a currency pair.
2. Volume determines the number of traders, those who are purchasing and selling currencies, who are taking part in the market. Volume is an important indicator because it uses the rule of supply and demand. Traders can monitor trends and know what positions to take by noticing whether there is a strong demand to increase the price of a currency. If there is, then they will notice the huge volume of participants in the market at that point.
3. Whether or not the price of a currency has been increased further than it should have been can be analyzed by using Bollinger bands. It also provides insight to a currency’s price target which allows traders to buy or sell depending upon their position according to that target price.
4. Traders use the Relative Strength Index to measure energy. It lets a trader know whether or not a currency has been oversold or overbought. And, if so, if a reversal is likely to occur.