An Introduction To Technical Analysis
Forex traders of all experience levels know that currency pair prices can do one of three things: Prices can go up, prices can go down, or prices can go sideways. With only those three potentials to consider, it would seem as though Forex trading would be easier than it is. After all, a trader holding a long position can only be hurt by the one potential, which is that of falling prices. If prices go up, the long trader earns profits and if prices hover in a sideways channel, well, no harm done.
Even new traders, including those who have been exposed to the Forex market only briefly through simulated trading accounts, quickly realise that Forex trading is extremely challenging. These traders, along with their more experienced intermediate and advanced counterparts, use analysis techniques to predict future price direction and to react to price changes as they happen in real time.
Types of Forex Analysis
Forex traders use fundamental and technical analysis to make their predictions and reactionary strategies. Fundamental analysis looks at long term historical exchange rates between any two paired currencies. It also considers the price impact of economic data that is released as news. These news events often quiet price changes before and after they are made public and cause wild gyrations in price in the minutes following their release.
Technical analysis, on the other hand, is a way of understanding price movement in the more immediate term of days, hours and minutes. Traders using technical analysis will sometimes be called chartists, because they rely on price charts to guide their trading actions.
Many traders will prefer or favour one of these types of analysis over the other, but in common practice, almost everyone will combine aspects of both types in the attempt to fully grasp the uncertainty of predicting currency pair prices.
A few of the key aspects of technical analysis can be found below:
Theory of Technical Analysis
At the heart of Forex technicians’ approach is the concept that all the elements that cause prices to change are shown on a price chart. All historical data, from the routine economic data news events that affect prices temporarily, to major world events with long-lasting implications, are displayed to provide assistance in predicting future prices.
Technical Analysis Basics
Forex charts combine a horizontal axis representing time on a grid with a vertical axis representing price. Simple analysis is possible from this alone. Prices that are historically high indicate a selling opportunity; low historical prices suggest a chance to buy currency pairs “on sale.”
Price bars are the next piece of the picture. There are more than a few types of price bar, but two of the most popular are the Open-High-Low-Close (OHLC) bar and the candlestick bar. For any given selected chart time frame, both these bars show traders the price when the bar began, its high and low points, and where prices were when the bar closed. The main difference between the two is that the OHLC bar has a uniform vertical thickness, whilst the candlestick has a wider body betwixt the open and close price levels. It is possible to construct effective trades and trading strategies from charts and price bars alone, such as when a trader uses them to find support and resistance price areas, selling when resistance is touched and buying at support levels. Many traders feel that trading from bare charts, those that have little other than time, price and price bars is the best way to discern truly the direction that prices take in the future.
Basic Technical Analysis Indicators
Looking only at the technical indicators supplied as defaults by Forex trading platforms, it will be seen that there are thousands of different technical indicators. The natural question arises: which indicators are best and which are of limited value?
That question has been asked since trading began. The closest thing to a simple answer is that the best technical indicator is the one that works best for a particular trader. That answer reveals something of the true nature of trading and the true nature of indicators. If there were one or several indicators that were bulletproof, effective 100 percent of the time, trading markets would cease to exist. Without uncertainty, there would be no speculative markets.
All that being said, below you’ll find a few technical analysis indicators that have been a part of most traders’ toolboxes for many years:
Forex traders use moving averages due to the proven idea that prices always return to an average of their highest and lowest levels. This reality will be seen best on price charts dealing with longer time frames, but it is also apparent on time frames as short as one minute. The shortcoming of moving averages is that whilst they effectively inform traders of where prices will go, they cannot reveal when prices will go there.
Forex trading platforms allow traders to draw lines connecting a series of low price levels, or a series of high price levels. Price trend lines that connect a series of higher highs are said to be revealing an uptrend, indicating a buying opportunity. An uptrend line will ascend from left to right on a chart. A trend line connecting lows on a chart with a series of lower lows and lower highs will descend from left to right on a chart and indicate a downtrend, offering a selling opportunity.
These are but two of the indicators that have served traders of financial instruments for decades. Combined with charts and price bars, they are the mainstay of many effective trading strategies. Other technical analysis indicators, however, may prove valuable to different traders and all traders should make learning about as many indicators as possible an ongoing goal of a Forex trading career. The beauty of this school of thought is that any of the Australian forex brokers offer suitable software to ‘tech trade.’
Some Forex Technical Analysis Questions
Is the Fibonacci Retracement indicator applicable to Forex trading?
What makes the Fibonacci Retracement indicator valuable is that it considers trader psychology. Prices seem to follow certain patterns that reflect human nature.
What parameters should be used with Bollinger Bands?
Bollinger Bands are a type of technical indicator known as an overlay indicator in that the bands are displayed right on the chart. They resemble the banks of a river in some ways. Traders use them based on the assumption that when prices touch an upper or lower band, prices will reverse direction as the market tries to contain prices within the bands. Another strategy is based on the idea that when prices do break one of the bands, they will do so with vigour, offering buying opportunities when the upper band is broken and selling opportunities when the lower band is broken. Like many technical indicators, experienced traders often use Bollinger Bands more to supply good trade exit points than for determining when to initiate a trade.