Technical analysis is a method used in forex trading wherein the price of a currency is determined by studying its market activity in the past and in the present to know financial data such as past prices, movement, and volume. Basically, instead of referring to various financial data, technical analysis relies heavily on charts and other tools to determine pattern which are suggestive of future movement.
While fundamental analysts believe that the key to forex trading is financial data, technical analysts believe that the key is the currency’s historical performance. For most traders, technical analysis is the easiest method because all that they have to do is to study charts and observe movement patterns. The challenge, however, is how to interpret the lines and patterns appearing in such charts.
In doing technical analysis, traders widely use two fundamental indicators in interpreting charts:
- Moving average
The moving average is the most commonly used indicator not only by beginners but also by experienced forex traders. Moving averages clear fluctuations shown by charts, making it easier for a forex trader to determine market trends and do the necessary actions, either to buy or to sell the currency.
Moving average is premised on its location with respect to the spot rate. When the spot rate moves under the moving average, the trader must sell, because the currency’s price is expected to go down after such point. On the other hand, when the spot rate moves over the moving average, the trader must buy, because the currency’s price is expected to go up after such point.
- Relative strength index
Relative strength index (RSI) is an indicator that goes up or down with respect to changes in market rates. Known as one of the most accurate indicators, the relative strength index relies on regions, or known as thresholds, to determine appropriate trading action.
Relative strength index is based on the historical movement of currency price, coupled with two defined regions- the first region with a scale from 0 to 30, and the second region with a scale from 70 to 100. When the RSI value falls within the first region, the trader must buy because the price is expected to go up afterwards. When the RSI value falls within the second region, the trader must sell because the price is expected to go down afterwards.
These methods are used because of their accuracy and relative suggestion of market trends. If one desires to choose technical analysis, he must consider using one or both of these methods in forex trading.