Technical
analysis is a method of predicting price movements and future market
trends by studying charts of past market action. Technical analysis is
concerned with what has actually happened in the market, rather than what
should happen and takes into account the price of instruments and the
volume of trading, and creates charts from that data to use as the primary
tool. One major advantage of technical analysis is that experienced
analysts can follow many markets and market instruments simultaneously.
Technical
analysis is built on three essential principles:

Market
action discounts everything! This means that the actual price is a
reflection of everything that is known to the market that could affect
it, for example, supply and demand, political factors and market
sentiment. However, the pure technical analyst is only concerned with
price movements, not with the reasons for any changes.

Prices
move in trends. Technical analysis is used to identify patterns of
market behavior that have long been recognized as significant. For many
given patterns there is a high probability that they will produce the
expected results. Also, there are recognized patterns that repeat
themselves on a consistent basis.

History
repeats itself. Forex chart patterns have been recognized and
categorized for over 100 years and the manner in which many patterns are
repeated leads to the conclusion that human psychology changes little
over time.
Forex charts
are based on market action involving price. There are five categories in
Forex technical analysis theory:

Indicators
(oscillators, e.g.: Relative Strength Index (RSI)

Number theory
(Fibonacci numbers, Gann numbers)

Waves
(Elliott wave theory)

Gaps
(highlow, openclosing)

Trends
(following moving average).
Tools for Technical Analysis
Relative Strength Index (RSI):
The RSI measures the ratio of upmoves to downmoves and normalizes the
calculation so that the index is expressed in a range of 0100. If the RSI
is 70 or greater, then the instrument is assumed to be overbought (a
situation in which prices have risen more than market expectations). An
RSI of 30 or less is taken as a signal that the instrument may be oversold
(a situation in which prices have fallen more than the market
expectations).
Stochastic oscillator:
This is used to indicate overbought/oversold conditions on a scale of
0100%. The indicator is based on the observation that in a strong up
trend, period closing prices tend to concentrate in the higher part of the
period's range. Conversely, as prices fall in a strong down trend, closing
prices tend to be near to the extreme low of the period range. Stochastic
calculations produce two lines, %K and %D that are used to indicate
overbought/oversold areas of a chart. Divergence between the stochastic
lines and the price action of the underlying instrument gives a powerful
trading signal.
Moving Average Convergence Divergence (MACD):
This indicator involves plotting two momentum lines. The MACD line is the
difference between two exponential moving averages and the signal or
trigger line, which is an exponential moving average of the difference. If
the MACD and trigger lines cross, then this is taken as a signal that a
change in the trend is likely.
Number theory:
Fibonacci numbers: The Fibonacci number sequence (1,1,2,3,5,8,13,21,34...)
is constructed by adding the first two numbers to arrive at the third. The
ratio of any number to the next larger number is 62%, which is a popular
Fibonacci retracement number. The inverse of 62%, which is 38%, is also
used as a Fibonacci retracement number.
Gann numbers
W.D. Gann was a stock and a commodity trader working in the '50s who
reputedly made over $50 million in the markets. He made his fortune using
methods that he developed for trading instruments based on relationships
between price movement and time, known as time/price equivalents. There is
no easy explanation for Gann's methods, but in essence he used angles in
charts to determine support and resistance areas and predict the times of
future trend changes. He also used lines in charts to predict support and
resistance areas.
Waves
Elliott wave theory: The Elliott wave theory is an approach to market
analysis that is based on repetitive wave patterns and the Fibonacci
number sequence. An ideal Elliott wave patterns shows a fivewave advance
followed by a threewave decline.
Gaps
Gaps are spaces left on the bar chart where no trading has taken place. An
up gap is formed when the lowest price on a trading day is higher than the
highest high of the previous day. A down gap is formed when the highest
price of the day is lower than the lowest price of the prior day. An up
gap is usually a sign of market strength, while a down gap is a sign of
market weakness. A breakaway gap is a price gap that forms on the
completion of an important price pattern. It usually signals the beginning
of an important price move. A runaway gap is a price gap that usually
occurs around the midpoint of an important market trend. For that reason,
it is also called a measuring gap. An exhaustion gap is a price gap that
occurs at the end of an important trend and signals that the trend is
ending.
Trends
A trend refers to the direction of prices. Rising peaks and troughs
constitute an up trend; falling peaks and troughs constitute a downtrend
that determines the steepness of the current trend. The breaking of a
trend line usually signals a trend reversal. Horizontal peaks and troughs
characterize a trading range.
Moving averages are used to smooth price information in order to confirm
trends and support and resistance levels. They are also useful in deciding
on a trading strategy, particularly in futures trading or a market with a
strong up or down trend. 