Being a forex trader, before getting into the juicy details of how to perform technical analysis, you first need to understand why this stuff works.
This is important because it will give you insight as to whether a level is worth trading or not.
Once you can see why it works, you’ll have a better understanding of what other traders (including banks) are looking for in a level.
This insight will give you guidance when analyzing your
What is technical analysis?
Technical analysis means making the trading decisions based on the price movement and time scale of a currency pair in the foreign exchange market.
Here, by “technical analysis” we are mostly referring to levels of support and resistance (supply and demand). After all, as price action traders that’s all we’re really after. We’ll leave all the other messy indicators to someone else. That’s not our kind of stuff.
There is an inherent difference between technical analysis in the equity markets and technical analysis in the Forex market. What is it? It’s that priorities differ between major players. In other words, the big boys like to keep their currency at specific levels during certain periods of time.
We all know the central banks are powerhouses in the Forex market. Whether you watch key levels or key news events, we all pay attention to areas at which they might intervene. We also know that some banks like to intervene more than others * cough cough * CHF and JPY. In our opinion, this leads to greater predictability than what you may see in the equity markets.
It’s a well-known fact that there’s about $4 trillion that exchanges hands every single day in the Forex market. However, there’s one problem with this figure. It’s wrong. The Forex market now averages more than $6.7 trillion a day ($5.3 trillion as of April 2013 to be exact). The odds are that the number is closer to $7 trillion a day now. This means that over the last few years the Forex market has increased more than 25% regarding volume. So now only is it the largest financial market in the world, it’s also the fastest-growing.
This is a huge advantage for us as price action traders. One of the major tenets of why technical analysis works is that it’s “self-fulfilling.” In other words, the outcome of a standard price action pattern is the result of the observation of the pattern and actions taken by other traders. Perhaps a better term would be “group” fulfilling. Either way, technical analysis works because enough traders see the same pattern, know the likely outcome and then take action.
The pin bar is a great example. We would argue that 90% of traders know this pattern as a potential reversal signal. Whether they call it a pin bar, a hammer or a shooting star, the shape of the candle is what stands out for most traders. When traders see this candle at a swing high or swing low, the market stands a good chance of reversing simply because enough traders are in alignment after seeing the pin bar.
Hopefully, you now understand why volume plays such a huge role when it comes to technical analysis. The more traders there are watching and acting on these technical patterns, the more likely they are to move in the intended direction. Once you analyze the price action of a pair, BINGO ! There you go!
Happy Trading! Best of luck!