Overview

Technical Analysis is the study of past price and activity history in order to predict future price movements. The basic premise of technical analysis is that the price discounts all information available in the market and that patterns in price movements tend to repeat themselves.

Another important foundation of technical analysis is that price movements are not random, but tend to trend in some direction most of the time. Although this seems an obvious fact to anybody that has ever looked at a chart, it is in fact a hotly disputed idea in certain academic circles. But then again, maybe that is why they are academics rather than traders...

The best practical introduction you can have to technical analysis is via the TradeFreedom Internet Trader, where the Green Eye system allows you interaction over the Internet with state-of-the-art technical analysis resources. In addition, our daily analysis, freely available to members, describes the most recent technical levels seen in the main currency markets.

For now, however, we would like to draw your attention to some of the most common and easily recognisable technical patterns:

Support & Resistance levels

When a market has been bouncing upwards from the same level a number of times, significant support can build up as more participants become aware of the level and try to buy very close to it. Such a support level may also be the result of a single very large buying order being placed at or just below the level. If the level is broken, however, a sharp move lower is often seen as traders will place stop-losses just below such a level to obtain a good risk/reward ratio.

When a market is being sold off from the same level continuously, the same factors are in play in the opposite direction and a resistance area is created.

Trend lines

Markets tend to trend higher or lower following fairly geometrical patterns. In an intact uptrend, you will see a series of higher highs and higher lows. If a connecting line is drawn between the rising lows, this is called a trend line and it will often be accurate in projecting where the market will find support on the next dips, thereby indicating good buying levels. When the price breaks lower through such a trendline, a sharp sell-off will often follow as many traders will have placed sell stop-orders just below the line for their long positions. Also, the break below an uptrend line is in itself a sell signal, attracting fresh sellers into the market.

In a downwards trending market, as series of lower highs and lower lows is normally seen. The trend line can here be drawn along the descending highs and mirrors the analysis described above.

Double (triple) bottoms and double (triple) tops

When a market retests a former low after a sizeable rally, it will often find support at the former low point. If this support is sustainable, a "double bottom" formation is created, which might signal a future move to significantly higher levels. A similar formation consists of three tests of the same level, forming a "triple bottom" formation. Another function of a double or triple bottom is to provide a good level for a technical sell stop-order against bought positions. Such a stop would be placed just below the prior lows.

When a market finds resistance two or three times at a given level over a longer period of time, this creates a double or triple top with the same implications in reverse.

Retracements

When a market is moving swiftly in a given direction, from time to time it pulls back as market participants take their profits. These are known as retracements and will normally create good opportunities to re-enter a market at attractive levels before the move resumes.

Such retracements are often of similar size and 50% retracements and 38.1% (Fibonaccio ratio) retracements, in particular, are watched for among technical traders.

Technical Indicators

A large number of technical indicators has been developed, mostly grouped into one of the following types:

Overbought/oversold indicators such as Relative Strength Index, Stochastics, Momentum etc.

Trend following indicators such as moving averages.

Trend deviation indicators such as Bollinger bands, Envelopes and the Flow Analysis developed by Green Eye.

All of these indicators are instantly available by simple clicks of a mouse button in the TradeFreedom Internet Trading system and the Green Eye Technical Analysis system available for clients and for members in the Simulation Trading Game. We strongly advise that you familiarise yourself with these concepts through practical implementation in the Simulation Trading Game.

While technical indicators can be a great help in trading the markets and are particularly valuable when fine-tuning entry and exit points, no technical indicator is infallible. So always apply common sense, strict stop-loss discipline and look at the underlying fundamental factors when entering into a trade.