Lesson 5: Basics of Technical Analysis

Technical analysis is a method traders use to study price movements in order to identify potential trading opportunities. Instead of focusing on economic news or political events, technical analysis relies on charts, patterns, and indicators to understand market behaviour.

This lesson introduces the core concepts every beginner should understand before using technical tools in real trading.

5.1 What Is Technical Analysis?

Technical analysis is the study of price action and trading volume to forecast possible future price movements.

In forex trading, this means analysing currency pair charts using visual tools and indicators. The main belief behind technical analysis is that:

All available market information is already reflected in the price.

Rather than asking why the market is moving, technical analysis focuses on how it is moving.

By studying historical price patterns, trends, and momentum, traders attempt to estimate:

Market direction
Trend strength
Possible reversal points

Subjectivity in Technical Analysis

One common criticism of technical analysis is that it can be subjective. Two traders may look at the same chart and reach different conclusions.

This difference usually comes from:

Tool selection
Timeframe choice
Personal interpretation

With experience, consistency improves. Learning how experienced traders apply technical analysis can significantly speed up the learning curve.

Traders who primarily rely on charts and indicators are called technical traders.

5.2 Candlestick Charts

Technical analysis is almost always performed on price charts, and the most widely used chart type is the candlestick chart.

Candlestick charts display four key price points for each time period:

Open
High
Low
Close

This format makes it easier to understand:

Market direction
Buyer and seller strength
Trend changes

By analysing individual candlesticks and candlestick patterns, traders can spot:

Trend continuations
Trend reversals
Market indecision

Candlestick charts also work extremely well with other tools such as:

Trendlines
Support and resistance
Moving averages

For a refresher on candlestick patterns, revisit Lesson 3: Essentials of Chart Reading.

5.3 Trendlines

Trendlines are one of the simplest and most powerful tools in technical analysis.

They help traders visualise market direction, which generally falls into three categories:

Uptrend
Downtrend
Sideways (range-bound) trend

How Trendlines Work

Trendlines are drawn by connecting:

Higher lows in an uptrend
Lower highs in a downtrend
Horizontal price points in a range

Trendlines help traders:

Identify trend direction
Anticipate potential price reactions
Estimate future support or resistance areas

As a general rule:

Trendlines drawn over longer time periods tend to be more reliable
Multiple price touches strengthen the validity of a trendline

5.4 Support and Resistance

Support and resistance levels represent key price zones where price tends to react.

Resistance

A price level where upward movement slows or stops
Acts as a “ceiling” for price

Support

A price level where downward movement slows or stops
Acts as a “floor” for price

Price often moves in a zigzag pattern between support and resistance levels.

Role Reversal of Support and Resistance

Market conditions can cause these levels to switch roles:

When price breaks above resistance during an uptrend, resistance becomes new support
When price breaks below support during a downtrend, support becomes new resistance

Identifying these levels helps traders:

Plan entry points
Set stop-loss levels
Manage risk more effectively

5.5 Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum indicator used to identify whether a market is overbought or oversold.

RSI values range from:

0 → Extremely oversold
100 → Extremely overbought

Common RSI Levels

Below 30 → Oversold conditions
Above 70 → Overbought conditions

RSI is useful for identifying potential reversal zones, but it should never be used alone.

During strong trends, RSI can remain overbought or oversold for extended periods, making it unreliable as a standalone signal.

Best practice:
Use RSI as a confirmation tool, not a decision-maker.

5.6 Moving Averages

A moving average smooths price data to help traders identify the overall trend direction.

It is considered a lagging indicator because it relies on past price data.

Commonly Used Moving Averages

50-period moving average
200-period moving average

Moving averages help traders:

Filter out market noise
Identify trend direction
Spot dynamic support and resistance levels

Moving Average Crossovers

Traders often use two moving averages together:

Short-term (e.g., 50-period)
Long-term (e.g., 200-period)

Signals:

Short MA crossing above long MA → Bullish trend
Short MA crossing below long MA → Bearish trend

Types of Moving Averages

Simple Moving Average (SMA): Equal weight to all prices
Exponential Moving Average (EMA): More weight to recent prices

EMA reacts faster to price changes and is preferred by short-term traders.

5.7 Technical Analysis vs Fundamental Analysis

These two approaches differ in focus but complement each other well.

Fundamental Analysis

Focuses on economic data and global events
Answers why price might move

Technical Analysis

Focuses on charts and indicators
Answers when to enter or exit trades

Using Both Together

Example:

A trader expects a currency to strengthen due to an upcoming political or economic event
Technical analysis is used to confirm trend direction and entry timing
If technical signals are unclear or conflicting, the trader may delay or hedge the trade

For beginners, learning both approaches provides a stronger foundation and better decision-making skills.