Whether you are trading stocks or currency, technical analysis is an advanced tool used to try and predict changes in your market and trade accordingly.
At the base of technical analysis is price history. You are studying the price of a currency, it’s up and downs, and looking for an obvious indicator that will tell you when another up or down is coming up. Think of it like trying to learn to read tea leaves to see the future – except there is real science behind it.
Using Charts For Technical Analysis
The most basic tool for technical analysis is your chart or graph. Whether you are looking at a line graph or candlesticks, the Forex trading chart is giving you a wealth of information. First, you can check the support and resistance. These are the points where it seems that the currency pair won’t cross. Is there a certain range in which the currency is moving? When you see a price making sudden movements in that range you can use the support and resistance to predict when it is going to change its direction again.
Trend lines can be used when there is a definitive pattern that you can follow. You can chart the trend line if it is moving in one direction to predict where the price is going to go using indicators.
For example, let’s say you are studying a candlestick chart -which you should as they give you more indicators in one convenient place. This type of chart can help you to find trends that indicate a major reversal is about to take place. One indicator you can look for is what traders refer to as “three white soldiers” which indicate a bullish reversal is pending.
The soldiers are three long white candlesticks in a row. The large body shows signs of struggle as the price jumps during the period of time, indicating that a change in feeling about the vitality of the currency is beginning to occur. Historically, traders believe that change is going to happen right after the 3rd white soldier appears. When you take the time to learn about candlesticks, make sure that you study the shapes of the candles and what they mean in order to best take advantage of their indicative ability.
Other Common Tools Used By Forex Traders
• Stochastic Oscillator: Using a scale of 0 to 100%, you can see if the currency has been overbought or oversold. Traders note that during a strong uptrend the closing price is going to be concentrated in the higher part of the range. Conversely, closing prices will be close to the extreme low in a strong down trend. By charting these two lines produced, you will wait for them to converge as this is a strong signal to trade.
• Relative Strength Index (RSI): The RSI also looks at overbuying and under-buying of currencies expressed in a range of 0 to 100. An RSI of 70 or above shows that the currency is saturated and the price is higher than expected. Oversold currency will show and RSI of 30 or lower.
These are two of the easiest technical analysis tools to learn, as their impact on the market should be obvious. When combined with chart reading, you can get a strong indication of when a pivot is about to take place by looking at the volume of investors interested in that pair.
Understand the Past to Predict the Future
Traders depend on their currency pair to act in the same way time and time again. To do this successfully you have to learn what key indicators were in place right before a major change, and then wait and watch for them to happen again.
All of the technical analysis tools and systems you will find have a basis in studying the historical trend. You can do this yourself by taking the time to look at charts, find the major change points, and then work backwards to see what, if any, indicators where in place. This will take some time as you need to go back and look over a series of currency pair changes in the market, but it will be time well spent once you pick up on the historical signs.
Self Fulfilling Prophecy?
It is also important to remember that technical analysis is subjective. In essence, you are relying on hundreds of traders to come to the same conclusions as you in their technical analysis. For example, with the “three white soldiers”, is it possible that the common knowledge of this indicator is actually causing the turnaround to happen. What if Forex traders where to call a truce on technical analysis for one week? Would the market still move the same, or is our analysis of it causing it to behave the way we expect it to?
Of course that is not going to happen, but you should have in the back of your mind that when charting trends, you are also charting and studying the habits of other traders and trying to predict what they are going to do when presented with the same data as you. This is a part of sentiment analysis, which relates very closely with the way technical analysis works.
Keep it Basic
For traders new to the Forex market, it is recommended that you start with the basics of chart reading and then choose one or two other technical analysis tools that you find helpful, such as one of those mentioned above. If you clutter your mind too much, you will end up over-analyzing and never getting anywhere.
Technical analysis is just one of the tools you are going to learn in the first year of Forex trading, but it is one of the easiest. Once you learn how to read and chart your graphs and pay attention to history, charting your currencies and making trading plans will start to come naturally.