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Technical Analysis
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Prior to the mid-1980s, the FX market was primarily dominated by funda­mental traders. However, with the rising popularity of technical analysis and the advent of new technologies, the influence of technical trading on the FX market has increased significantly. The availability of high leverage has led to an increased number of momentum or model funds, which have become important participants in the FX market with the ability to influ­ence currency prices.

Technical analysis focuses on the study of price movements. Technical analysis use historical currency data to forecast the direction of future prices. The premise of technical analysis is that all current market infor­mation is already reflected in the price of each currency; therefore, study­ing price action is all that is required to make informed trading decisions. In addition, technical analysis works under the assumption that history tends to repeat itself.

Technical analysis is a very popular tool for short-term to medium-term traders. It works especially well in the currency markets because short-term currency price fluctuations are primarily driven by human emotions or market perceptions, The primary tool in technical analysis is charts. Charts are used to identify trends and patterns in order to find profit opportunities. The most basic concept of technical analysis is that markets have a tendency to trend. Being able to identify trends in their earliest stage of development is the key to technical analysis. Technical analysis integrates price action and momentum to construct a pictorial representation of past currency price action to predict future perfor­mance. Technical analysis tools such as Fibonacci retracement levels, moving averages, oscillators, candlestick charts, and Bollinger bands pro­vide further information on the value of emotional extremes of buyers and sellers to direct traders to levels where greed and fear are the strongest. There are basically two types of markets, trending and range-bound; in the trade parameters section (Chapter 7), we attempt to identify rules that would help traders determine what type of market they are currently trad­ing in and what sort of trading opportunities they should be looking for.

Is Technical Analysis or Fundamental Analysis Better?

Technical versus fundamental analysis is a longtime battle, and after many years there is still no winner or loser. Most traders abide by technical analysis because it does not require as many hours of study. Technical an­alysts can follow many currencies at one time. Fundamental analysis, in contrast, tend to specialize due to the overwhelming amount of data in the market. Technical analysis works well because the currency market tends to develop strong trends. Once technical analysis is mastered, it can be applied with equal ease to any time frame or currency traded.

However, it is important to take into consideration both strategies, as fundamentals can trigger technical movements such as breakouts or trend reversals, while technical analysis can explain moves that fundamentals cannot, especially in quiet markets, such as resistance in trends. For ex­ample, as you can see in Figure 3.4, in the days leading up to September 11, 2001 , USD/JPY had just broken out of a triangle formation and looked poised to head higher. However, as the chart indicates, instead of breaking higher as technicians may have expected, USD/JPY broke down following the terrorist attacks and ended up hitting a low of 115.81 from a high of 121.88 on September 10.

Figure 3.4 USD/JPY September 11, 2001 , Chart

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