Technical analysis is the process of using mathematical tools to predict the future direction of an asset. The asset can be currencies, stocks, bonds, and commodities. The basic idea behind technical analysis is that it is possible to predict how an asset will move by using historical data and adding some statistical formulas. Technical analysis is the exact opposite of fundamental analysis, which uses economic and financial data and news.
Visual Look of the Chart
The first step in technical analysis is to look at the chart visually. A simple look at a chart will give you a lot of information. For example, it will tell you whether the price of the asset is consolidating or whether it is trending. It is always difficult to conduct technical analysis for a chart that is consolidating.
As you look at the chart, you should consider the periods very carefully. This is because the period you decide to use will depend on your trading strategy. For example, if you are a scalper, it will be unnecessary to use a daily chart. If you are a swing trader, it will be dangerous to do technical analysis on a weekly chart.
You should also look at the type of chart you are using. There are three types of charts in MT4; bar charts, line charts, and candlesticks. We recommend that you use candlesticks because of the additional information they tell you.
Identify Support and Resistance Levels
The next step in technical analysis is to identify the support and resistance levels. A support level is a level where the price of an asset struggles to move below. It happens when short sellers start to question the overall trend of the asset. A resistance level, on the other hand, is a ceiling where the price of an asset fails to move over.
There are various ways of identifying the support and resistance levels. A common method is to identify psychological levels. An even number is a common psychological level. For example, the USD/CHF pair below shows that the pair struggled to move above parity (1.100). In this case, 1.100 is an important resistance level.
Another way of identifying support and resistance levels is to identify pivot points. Pivot points are important levels that can help you identify the trend of an asset and identify these levels. There are several types of these pivot points. The most common ones are standard pivots, DeMark Pivots, and Fibonacci pivots. The latter uses the ancient mathematical concept of the Fibonacci sequence. The chart below shows the Fibonacci Retracement applied on the USD/CHF pair.
In short, support and resistance levels are important because they show you the direction of the asset. They also show you the ideal places to put a stop loss and a take profit.
Using Technical Indicators
Technical analysis is not enough without using indicators. Indicators are tools created using mathematical calculations that can help you forecast the direction the currency pair will move in. There are thousands of these indicators. In MT4, more than 50 indicators are provided as a default. You can find these indicators by going to the Insert tab as shown below.
These are not the only indicators. You can find thousands of other indicators in the MQL4 website. Another option is to find them in the Codebase as shown in the chart below.
All these indicators are primarily divided into three. First, there are trend indicators, which are used to identify a trend in a chart. The most common trend indicators are moving averages, Parabolic SAR, Ichimoku Kinko Hyo, and the Average Directional Index among others. All these indicators are lagging indicators.
Second, there are oscillators. These indicators are primarily used to identify when the price of an asset is overbought or oversold. Some examples of these indicators are the Relative Strength Index (RSI), Stochastic Oscillator, and the Relative Vigor Index (RVI). These are classified as leading indicators.
Third, there are volume indicators. These indicators incorporate the idea of volume in their calculations. In most cases, they are usually oscillators that incorporate volumes. Examples of these are the money flow index (MFI), accumulation/distribution, and on balance volume among others.
As a trader, you must learn how to use some of these indicators because you will need to use them. You don’t need to know how to calculate them. Also, you need to know how to use the periods because you need to tweak them based on your trading strategy.
Example of Technical Analysis
There are various ways of using technical indicators when trading. One way is to combine several indicators in one chart. For example, you can combine two moving averages and an oscillator like Stochastics and the Relative Strength Index (RSI). The importance of combining these indicators is for confirmation and to avoid a false breakout. In the chart below, a sell signal was created when the short and medium-term exponential moving average made a bearish crossover. As it did this, the RSI was at 91, which is considered an overbought level.
There is no single way of performing technical analysis. You will find diverse information about all indicators that you research on. For example, some will tell you to buy whenever the RSI crosses 70 and short when it crosses 30. Others will tell you to do the opposite.
The secret to success is to take time and create a trading strategy using a demo account. You should also backtest your strategy to see how it works. Also, you should avoid the temptation of using many indicators on a chart. In most cases, these indicators will give you mixed signals. Finally, you should never use any indicator when the price is consolidating. Doing this will give you the wrong signal.
Technical analysis is a very common trading strategy that is used by many traders in Wall Street. For beginners, the industry can seem complicated and diverse. Therefore, taking time to learn about it and testing it using a demo account will help you polish your skills in this type of analysis.