Approaches to Trading the Market – Technical Analysis

Technical Analysis

Technical analysis is the method of evaluating traded products by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts believe that the price contains all known information and therefore technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

With wonderful sounding names such as Elliot Wave Theory, Candlestick Charts, Moving Average Convergence Divergence or Bollinger Bandsthey all have the common aspect of presenting us with a visual approach to market analysis.

In the section we introduce you to a handful of methods that are currently applied to the market.

Support and resistance

Support is the price level at which demand is thought to be strong enough to prevent prices from declining further. Support levels are below the current price, though it is not uncommon for prices to dip below support briefly signaling a false breakout. With a support level broken, the market will move lower indicating that the sellers have overwhelmed the buyers. Once a support level has been broken, another support level will be established at a lower level and the tendency is that support level that was breached, will now become a resistance level.

Resistance is the price level at which demand is thought to be strong enough to prevent prices from rising further. Resistance levels are usually above the current price. A clear break above the resistance level signals that the buyers are in control. In this instance there are fewer sellers and the price tendency is to move further up. Once a resistance level has been broken, another resistance level will be established at a higher level and as with the support level, when the resistance level is breached, this will now become the new support level.

Moving Averages

Moving averages are very popular tools used by technical traders to measure momentum. They are usually the first tool that technical analysts are introduced to as they are simple to apply and are building blocks to more complicated moving average theories. The main purpose of these averages is to smooth price data so traders can be in a better position to gauge the likelihood that a current trend will continue. Moving averages are commonly used to predict areas of support and resistance and are also used in conjunction with other indicators to help give more accurate entry and exit signals. There are different types of averages that vary in popularity but, regardless of how they are calculated, they are all interpreted in the same manner.

We have simple moving averages, weighted moving averages and exponential moving averages.

A very simple theory is the moving average crossover. This is where you combine two moving averages with differing time frames. Where they cross will indicate the entry and exit points to a trader.

Fundamental Analysis

Fundamental analysis is the study of the core underlying elements that influence and impact on the underlying price of a security or a country’s economic well being. This method of study attempts to predict price action and market trends by analyzing economic indicators, government policy and other factors. Whilst fundamental analysis may help you forecast an underlying real value for a stock or share, when it comes to fundamental analysis for the foreign exchange markets, the analysis is carried out to forecast economic conditions and underlying direction. Therefore for the currency markets, fundamental analysis is not an exact science to predict price. For example, you might get a clear understanding of the health an economy by studying an economist’s forecast of an upcoming economic release but that will not give you entry and exit points, simply price direction.

Fundamental analysis and the resulting figures will involve interest rates, central bank policy, political figures or events, employment reports; whether seasonal or unemployment figures, gross domestic product (GDP), etc. These economic indicators are snippets of financial and economic data published by various agencies of the government or private sectors for each country. These statistics, which are made public on a regularly scheduled basis, help traders monitor the health of the economy.

Fundamental analysts broadly label economic data and news releases into three categories. The release is either there to reflect the current state of the economy which is referred to as a coincident indicator, is alternatively known as a leading indicator as the release will look to predict future conditions or is finally known as a lagging indicator.