The foreign exchange market uses two different ways to predict the movement of prices and to purchase contracts 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 determine past trends with the hope that past trends will help establish future price movement.
Advantages of Technical Analysis
Technical analysis ignores all external factors, including the social, political, and economic state of the country. It is assumed that these factors have already impacted the current exchange rate so it’s not necessary to analyze these independently. Despite the fact that different currency pairs are being monitored, technical analysis results in fewer inconsistencies. The flow of resources and the action of individuals participating in the market has the largest impact upon the movement of 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 determine whether a currency pair will continue to either increase or decrease, 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 indicators used in technical analysis, including support and resistance levels. Technical Analysis also uses volatility based indicators, ranging indicators, moving average based indicators and volume based indicators. These can all be used in the Foreign Exchange Market to make money.
1. Moving average based indicators (also known as MACD) can be used to determine and confirm if prices are trending. This indicator can be used in divergence trading. It also has its own signal line which can be used to notify traders about the right time to buy or sell a currency pair.
2. Volume determines the number of traders, both buyers and sellers, who are taking part in the market. Volume is an important indicator because it uses the law of supply and demand. Traders can monitor trends and know what positions to take by noticing whether there is a strong pressure to increase the price of a currency. If there is, then they will notice the huge volume of participants in the market during that period.
3. Whether or not the price of a currency is overextended 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 price target.
4. Traders use the Relative Strength Index to measure momentum. It tells a trader whether or not a currency has been oversold or overbought. And, if so, if a reversal is likely to occur.