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Technical Analysis In Forex - The Good And The Bad

By : TJ Chiam
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Technical analysis is a method of forecasting future price movements and market trends primarily through the use of charts. Technical analysis is only concerned with how the market has actually behaved, rather than what should happen, and takes into account the price of instruments and the volume of trading. Charts are then created from that historical data and used as a primary tool for analysis. One major advantage of technical analysis is that experienced analysts can follow many markets and market instruments simultaneously.

Three Principles of Technical Analysis:

Market action discounts everything! This means that the actual price has already been determined by every bit of information that is known to the market. Hence, fundamental issues such as inflation, interest rates, public sentiment, market supply and demand, political factors will not affect the market prices.

Prices move in trends Technical analysts believe that prices have to follow a trend, whether upwards, downwards or sideways. The Dow Theory of market price action states that the market cannot be manipulated. Once a pattern is created, there is a high probability of it producing an expected result. There are also recognized patterns that repeat themselves on a consistent basis.

History repeats itself Technical analysts believe that investors collectively repeat the patterns of investors before them. That is to say, human psychology changes little over time. Since patterns have worked well in the past, it is assumed that they will continue to work well into the future. Because investor behavior repeats itself so often, it is possible to chart recognizable market patterns for analysis.

Disadvantages of Technical Analysis

- Critics of technical analysis include many well know fundamental analysts. Warren Buffet once said, "If past history was all there was to the game, the richest people would be librarians."

- The critics also claim that signals about the changing of a trend appear too late, often after the change had already taken place. Therefore, traders who rely on technical analysis will react too late.

- Technical analysis made in short time intervals may be exposed to noise, and this can result in erroneous reading of market trending.

- The use of most patterns has been widely publicized in the last several years. Many retail traders are quite familiar with these patterns and often act on them like a herd mentality. This creates a self-fulfilling prophecy, as waves of buying or selling are created in response to bullish or bearish patterns.

Advantages of Technical Analysis

- Many traders say that trading in the direction of the trend is the most effective means to be profitable in financial or commodities markets. Many famous traders have each amassed massive fortunes via the use of technical analysis and its concepts. George Lane, a technical analyst, coined one of the most popular phrases on Wall Street, "The trend is your friend!"

- Technical analysis can be used to project movements of any asset (which is priced under demand/supply forces) available for trade in the capital market.

- The technical approach concentrates on prices, which neutralizes external factors. Pure technical analysis is based on objective tools (charts, tables) while disregarding emotions and other factors.

- Signaling indicators can sometimes indicate the imminent end of a trend, before it shows in the actual market. With this, the trader can choose to take profit or cut losses.

About the author:
TJ Chiam is an avid forex trader and writer. Did you know only 25% of forex professionals use technical analysis as their primary decision making tool? Learn how to trade the forex market like a pro. Visit" target=_blank>

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