Why is the Foreign Exchange Market the Best Market to Use Technical Analysis?

By: Market Publications

The following is an excerpt from Market Publication's The Beginner’s Guide to Success in Today’s Amazing FX Currency Markets

The foundation behind using technical analysis is to find trends when they first develop, which allows the trader to ride the trend until it ends. The foreign exchange market is typically composed of trends and is, therefore, a place where technical analysis can be effective. Traders are able to speculate on both up and down trends in the foreign exchange market because it is possible to buy a currency and sell against another currency. This aspect of currency trading works well with technical analysis, because technical analysis helps determine where the trends are and which way they are going, thus giving the trader a chance of profiting from the market, regardless of its direction.

In comparison to equities and futures markets, technical analysis is much more common and popular within the foreign exchange markets, which causes the traders to pay attention. The market partly moves because of all the technical analysis performed. For example, according to technical analysis, if a currency pair decreases, then the majority of traders will sell the pair, causing it to drop further.

Support and Resistance

At the core of all technical analysis theory are two very simple concepts; support and resistance. Support can be defined as a "floor" through which the currency pair has trouble falling below. There is not scientific formula for calculating support; it is something that is typically "eyeballed" by traders, and hence involves somewhat of a subjective element.

Resistance, on the other hand, is simply the opposite; it is the upper boundary through which a currency pair has trouble breaking. Similar to support, resistance levels are somewhat subjective. Generally, if the market reaches a certain number of time and cannot sustain a break above that level; is can be identified as resistance.

The reason why price has trouble breaking these levels is the presence of actual orders around these levels. A support level is simply a price area where buy orders tend to be, and so it takes more than normal selling pressure to break that level. Similarly, a resistance level is a price area where well orders tend to be, and so it takes more than normal buying pressure to break that level.

Support and Resistance in Range-Bound Markets

On simple way to use support and resistance in trading is to simply trader the range: in other words, traders can simply buy at a support level, and sell at a resistance level. A key advantage of this is that the FX market is range-bound a majority of the time, making it an attractive strategy for many market conditions.

The downside of range-bound trading though is two-fold. Range-bound trading generally does not yield substantial gains on a per-trade basis.

When the market breaks out of the range, it will often make big moves. As a result, traders using range-bound strategies can suffer large losses when the market breaks out of the range.