Ok, so you went through part 1 of technical analysis in forex trading and saw how support and resistance levels can help you determine a good moment to buy or sell.
However, we have not answered some of our initial questions:
Which currency pair should I buy? Or
Should I buy or sell this pair?
We cannot answer these questions with technical analysis.
Wait, but I thought forex technical analysis was the holy grail of currency trading.
I’ve heard of so many trading systems and tools such as moving averages, momentum, Bollinger bands, Fibonacci ratios, and… this, and that, and so on… and so forth…
If you want to make money trading forex, we first have to recognize the limitations of technical analysis.
Let’s step back for a moment, who are the traders who make a ton of money?
Is it Sam, a retail trader working from his home? Maybe.
What about John, a senior trader at a top bank in Wall Street? Hmmm. John has a salary, and benefits.
If you were the owner of the bank and you paid John $300,000 a year, how much would John have to make trading?
Clearly, John has to make more (in practice substantially more) than his pay over the years if he wants to keep his job long term.
Moreover, these banks are top dogs for a reason. They are extremely competitive, so they gravitate towards best trading practices.
I understand, but what are those best trading practices?
Professional traders place much more importance on forex trading fundamentals than technical analysis. Because that’s what works (they still use technical analysis it’s just less important).
I don’t believe you.
Why then are so many people into technicals?
Because they are easy
After all. Why bother learning about economic indicators and Central banks or trying to decipher the market’s fundamental forces each and every time I’ll do a trade, when I can just use a system I saw in a forum?
When you use a trading system based solely on technical indicators, you just wait for the price to hit a threshold and behold! You buy or sell the pair.
No need to think.
And if the trade goes wrong, it’s the system’s fault. I can just tweak it a little and it will work next time.
If it doesn’t, I can just find a different system and try again.
Another reason it’s deceivingly easy to settle for a purely technical strategy is the opportunity to back test a system.
The way it works is you find or develop a cool trading system based on several technical tools.
Say, if a short term moving average crosses a longer term moving average, you have a signal to enter the trade.
Then you check whether it would have made you money last month.
Turns out that if you had used this system then, you would have made a lot of money trading forex.
You also test other time periods and get similar results. By now, you feel very confident. You start trading and lose your position.
What happened? Why do people lose money this way? Prices do not behave the same way.
Ask yourself: is this market the same it was in the period I back tested the system?
Chances are, fundamentals have changed, or perhaps, the market is in a period of high volatility. If you neglected fundamental analysis, you will have no idea.
Do you want to be the guy who has no idea of what’s going on?
Lastly, it is much easier for opportunistic sellers to make up new technical indicators (there is probably an infinite amount of possibilities).
Thus, you see new things popping up every time. Coupled with people’s desire for easy, you get a good business from selling these systems (or writing books on them).
Now, I don’t want you to leave thinking that technical analysis is garbage.
There is a place for it in almost every trading strategy. So what is the best use of technicals?
Let’s say you think the EUR/USD will continue to go down.
You researched the pair’s fundamentals and you are certain that both the FED and the ECB will continue to use divergent monetary policies.
Naturally, you decide to go with the downward trend and sell the pair.
You get your EUR/USD chart and fair enough. For the past few days the price has fallen. But there are some momentary increases.
This is where technical analysis will aid you. You want to sell. But you would prefer to enter the trade at a time in which the price is relatively high (in one of those short term upward moves).
Why? Because you know that long term, the price will continue to move down. But at any one moment it could move back up.
So you can capture one of those moments to increase your profits and set a better stop order.
You could draw support and resistance levels and wait for the price to get close to the latest resistance level.
You know from part 1, that the price is more likely to fall from a resistance level.
This time, however, you did some fundamental analysis and also know, that market forces will drive the price down.
Hence, you are more likely to be right about this trade.
And thanks to a few technical analysis tools, you might just make some money trading forex.
That’s what we have for technical analysis.
Just make sure you understand the forces moving currency prices here. And if you already now, make sure you check out our newsletter here.Home > Forex Trading Basics > Forex Technical Analysis Part 2
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