Forex Tech Analysis

Predicting the Market (Part 1)

So now we’ve gone over the basics of the Forex market and how to start your own account.  But a key component has been left undisclosed until now: how to make money in the market.  All traders in the market are trying to do the same thing, that is, trying to predict the next trend the market will take on.  Everyday, hundreds of thousands of traders are sitting studying charts and numbers hoping that these bits of information will divine the future.

It is important to know past highs and lows that markets have achieved.  These levels of resistance have a big influence on where the market goes.  In fact, technical analysis charts are great for identifying past trends.  A lot of information can be gleaned from these charts, including resistance lines and moving averages.  But these predictors cannot tell the future.  They merely hint at where the market is headed if (and this is a big if,) the market continues as it has been.  Markets are volatile and subject to the gray-area laws of supply and demand.

To gain a further understanding of the effects of demand, let me give an example.  Let’s assume that apples sell for $0.10 each.  If the desire of consumers to buy apples is strong, the seller may raise prices knowing that the apples will still sell.  So the price of an apple is now $0.12.  Still, people flock to the store to buy apples.  Prices are raised again; now apples cost $0.14.  Around this time, some buyers begin getting timid.  They don’t want to buy apples at $0.14 because they think that tomorrow they will be able to get the same apples for $0.13.  So now there is slightly less demand causing prices to drop.  Apples are now at $0.13.  The people who waited were right, and the others who were content buying them at $0.14 are now excited because they are getting an even better deal, so even more apples are bought.  This drives apples up to $0.16 each.  This is too expensive for many apple-investors, so they stop buying apples all together.  Soon, prices of apples have plummeted to $0.12 again, bringing apple buying back into style.  The following chart illustrates each phase of the demand for apples.

This is the reason why oscillations in historical prices are so rampant.  When there is the thought that the price of something will continue to increase, people will buy it right away thinking they are getting a better deal than they would get the next day.  If you think that the value of the Yen is about to go up, you will want to buy for as cheaply as possible, knowing that when the Yen does go up, you will be able to sell them for a big profit.

Technical analysis charts capture these ups and downs and try to extrapolate the future based on the past.  What technical analysis cannot do is predict how political, economic, and psychological factors will precisely influence future prices.  For example, if you take an average of all the different phases in the chart above, you discover that the average price of an apple over the given time period was $0.13.  Since the chart ends at $0.12, does this mean that the price of apples is bound to go back up?  Or is the sharp drop off towards the end of the chart indicative of more price cuts to come?  Technical analysis alone gives us mixed signals.  We must look at other factors to answer these questions.