Part II. Technical analysis

Technical analysis in the Forex market is one of the tools used to forecast currency exchange rate movements. This type of analysis is based on the assumption that the trend of currency exchange rates is already embedded in the history of their past fluctuations. This assumption is grounded in the widely accepted belief that history tends to repeat itself. Traders who employ technical analysis construct charts of currency exchange rates, identify trend lines on these charts, identify trend reversal patterns, and calculate various mathematical indicators. Based on this information, they make decisions on opening long or short positions on currency pairs.

It is important to understand that fluctuations in currency exchange rates in Forex are driven by human activity. Currency rates do not follow any physical laws, and it is impossible to derive an exact formula for their fluctuations. Nevertheless, throughout the history of financial markets, numerous attempts have been made to bring the fluctuations of traded instruments under a systematic framework. This system found its embodiment in the form of technical analysis, which consists of a set of tools that will be discussed in subsequent chapters.

Traders in the Forex market, with respect to a specific currency pair, can be classified at any given moment as those who buy the currency (bulls), those who sell it (bears), and those who do not show any activity in that currency pair. Based on the supply and demand model, if a currency is being bought more actively than it is being sold, the demand for it increases, and its price rises. Conversely, if a currency is being sold more actively than it is being bought, the demand for it decreases, and along with it, the price of the currency decreases. As a trader in the Forex market, it is important for you to timely identify which side (bulls or bears) has the majority so that you can align yourself with that majority. The majority is determined not by the number of participants but by the size of their capital. The fact that technical analysis theory is widely used by traders with large capital is precisely why such theory works in the first place. The more widespread a particular technical analysis technique is, the more likely it is to work because traders incorporate it into their practice.

Indeed, that is why, when using technical analysis, it is advisable to adhere to the well-known rule that simplicity is genius. The more easy to learn and use a particular technical analysis tool is, the more traders will use it, and the more likely it is to work. Therefore, inventing something new in the theory of technical analysis in financial markets is almost pointless. Your developed indicator will only work if it gains widespread adoption on a global scale and is used by the majority of traders. As an exception, it can be considered that your developed indicator may also work if it is based on other widely used indicators.

Indeed, the dilemma of technical analysis can be compared to the "which came first, the chicken or the egg" dilemma. Either the fluctuations in market prices can be mysteriously explained by the formation of patterns on charts and the calculation of mathematical indicators with a certain degree of probability, or the fluctuations in prices are explained by the theory of technical analysis simply because the majority of people believe in it. We adhere to the latter opinion. However, you may form your own opinion on this matter. Regardless, technical analysis works, and it is essential to study it. Without using technical analysis, trading in the Forex market becomes akin to playing roulette. In the subsequent sections of the website, the basics of technical analysis in Forex will be examined in detail.

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