To earn money on FOREX, commodity or the equity market, a trader should either buy an asset and sell it higher or sell it and then buy back lower. This however, is not that simple. The key to a successful transaction is to know when the price is relatively low or high, and then - is it going to fall or to rise? In order to achieve that, traders basically use two types of investment analysis: - Fundamental analysis - method of predicting exchange rate movement on the basis of economic and political data and factors, those influence supply and demand of currencies, commodities or equities and other markets.
· Technical analysis - method of predicting exchange rate movement and future market trends on the basis of charts, oscillators and other indicators constructed from historic exchange rates and turnover data.
In practice investors usually apply both investing techniques, combining methods and relying on their own investment experience.
General Information and Principles
Before describing how investors use technical analysis in order to predict future price movement, the general definition and prime principles of technical analysis cannot be omitted. Technical analysis is the study of price movement on the basis of charts. It is also the study of repetitive price patterns portraying our psyche. The first notes with regard to the subject date back to XVIII century Japan, where a rice trader described that without price analysis no one could become a successful trader. He didn’t know then, that in the future there would be a possibility to actually earn or lose money by predicting what prices could do in the future.
Technical analysis is based around three prime principles:
1. Market action discounts everything
What this means is that to a technical analyst, everything that happens around us from natural disasters to presidential elections, is portrayed in the price itself. Things happening around us obviously do affect the market price, but this can be anticipated or observed on the charts themselves.
2. Prices move in trends
If you take a look at any chart you could realize that prices move in trends, keeping hold of one long term trend. Obviously even a long term trend could change and does on many occasions but most of the time prices remain in the main trend. Larger trends are divided into smaller ones which are also later divided into even smaller ones…etc. From this principle we could reach a significant conclusion which will also be our most important rule. It comes from George Lanes famous words “The trend is your friend”. More about the trend itself will be discussed in later materials but bare in mind that these words should NEVER be forgotten.
3. History likes to repeat itself
Technical analysis as mentioned before is the analysis of repetitive price patterns. How and why are these patterns repetitive? The answer is quite simple but on the other hand very complicated. It is simple due to the fact that these patterns portray our behavior and our psyche; they portray what we do and how we react to different market events. The complicated part is that these patterns are often very precise what shows, that people behave exactly the same way now as they did in the distant past. It is easy to realize, but nearly impossible to explain. It seems like a “Big Brother” is watching over the market and precisely controlling what occurs. If an investor takes hold of the knowledge necessary to understand the repetitiveness of market patterns, then he is on a good way to earning lots of money.
Technical Analysis
How to survive on investment markets
Investors should keep in mind that both technical and fundamental analysis is not enough to earn money on investment markets. Investors often forget about two significant aspects. The first is the management of our capital and the second is market psychology. Here are a set of basic rules that will help you achieve your goals in the world of investment.
Rules:
- Always open positions in the direction of the trend. Never break this rule even if it helps you earn money a few times. Break this rule and you will learn that the market is the ruler of the world of investments and unfortunately not the investor.
- Keep a hold of your plan. You should forge a plan according to which you will invest your money with the addition of strict rules that should never be broken whatever the circumstances. Strict rules will help eliminate emotions like hope, greed, fear and many other emotions that could prove destructive on the market.
- Do not invest all your capital in one particular investment. 10-20% of your capital in one transaction should be enough.
- Do not change the level of your stop loss with hope that the market will change direction. Hope will lose you money and should be eliminated.
- Cut losses as soon as possible. On the other hand do not fear losses. They are part of the game.
- Do not be afraid to earn money. Hold winning positions as long as possible. Remember that before opening a position you should have an aim. If this aim is fulfilled then you may close your position, never earlier.
- Do not force yourself to open a market position. If you do not see anything happening, just take a break.
- Always evaluate how much you can earn in comparison to what you can lose. Try to hold at least a 3:1 relation.
- Note down all your transactions. Analyze both the winning and losing transactions. By doing so you will not only understand your mistakes but you will understand your emotions when making different decisions.
- Do not invest in a group. The more opinions, the more emotions. Does this mean that you should not read the analysts comments and reports? No, but it does mean that if you have a planned position, then do not change your decision upon reading some analysts differing opinion. Why should you be wrong? And remember, analysts are not always good traders.