FOREX TECHNICAL ANALYSIS

FOREX analysis is divided into two types: Fundamental and Technical. Fundamental analysis attempts to predict movements in currencies by examining current political and economic events. Technical analysis uses historical economic data to predict movements in the FOREX. These two articles will examine the principles of technical analysis and the tools involved.

Basic Principles

Technical analysis is based on three assumptions :

Is Technical Analysis Necessary ?

Most FOREX day traders rely heavily on technical analysis and may use fundamental analysis to support their trading strategy. A major advantage of technical over fundamental analysis is that it can be applied to many different markets and currencies at the same time. Fundamental analysis requires in-depth knowledge of the political and economic conditions of a certain country; therefore it is less likely that any one trader can do proper fundamental analyses on more than a few countries.

The beginner trader may be put off by the seeming complexity of technical analysis and wonder if it is necessary for FOREX trading. As with any investment, FOREX trading requires a strategy. Although any strategy is possible, technical analysis is a proven method for predicting movements in the FOREX. Does that mean it’s a sure thing? Nothing is 100% certain, and currency prices are affected by a variety of forces. This is why many traders use a combination of technical and fundamental analysis to plot their trading strategies.

Availability

Every FOREX online broker should provide access to a wide variety of charts for technical analysis. Some charting software is available free of charge while in-depth professional charts may carry a monthly fee. Charts can be viewed by various time scales and provide detailed information about price movements as well analytical overlays. Charts can be zoomed in to the tick level or zoomed out to see the broad picture over a period of months or years. Charts are updated in real time.

FOREX charts may be available on your broker’s web site or may be included as part of their trading software.

Before beginning in FOREX trading it is a good idea to become accustomed to market behaviour by following charts for a period of time and studying their movements and learning about trends. Many brokers provide practice accounts that can be used by beginners to place ‘paper’ bids - no real money is exchanged. These practice accounts familiarize the beginning trader with FOREX charts and market movement while at the same time allowing him to become acquainted with the trading software a particular broker uses.

Price Charts

Price Charts show information about FOREX prices at specified intervals of time. Intervals can be from one minute up to several years and everything in between. Prices can be plotted with simple line graphs or the price variation for each interval can be shown by a bar or candlestick pattern.

Line charts are suitable for getting a broad overview of price movements. They show the close price at the chosen intervals. Line charts are very clean to read and make it easy to spot patterns, but they lack the detail of bar and candlestick charts.

Bar charts offer much more information than line charts. The length of each bar indicates the price spread for the given period - a long bar indicates a large difference between high and low prices. The left tab on the bar shows the opening price and the right tab show the closing price. You can see at a glance whether the price fell or rose for that particular period, and what the price variation was. Bar charts printed on paper (especially for short periods) can be difficult to read, but software charts usually have a zoom function that makes it easier to read closely spaced bars.

Candlestick charts were invented by the Japanese for analyzing rice contracts. They are similar to bar charts in that they indicate open, close, high and low prices for a given period. They are easier to read than bar charts, however, because of their color coding. Green candlesticks show rising prices and red candlesticks show falling prices.

Candlestick shapes - when viewed in relationship to neighbouring candlesticks - provide indicators of market movement that can aid in chart analysis. Various shapes of candlesticks are formed according to price spread and the proximity of opening to closing prices. Candlestick patterns have been given fanciful names like ‘morning star’ and ‘dark cloud cover’ and once the shapes have been learned, they are easy to pick out on a chart for identifying trends in the market.

Price charts are usually supplemented with technical indicators. There are many Technical Indicators broadly divided into different categories. Trend indicators, strength indicators, volatility indicators, and cycle indicators are just some of the analytical tools used to anticipate movement and market volume.

Some of the most common technical indicators used in FOREX are :

Average Directional Movement Index (ADX) - is used to determine if a market is entering a trend (either downward or upward) and how strong the trend is. Readings over 25 indicate a trend with higher values indicating stronger trends.

Moving Average Convergence/Divergence (MACD) - shows the momentum of the market and the relationship between two moving averages. When the MACD line crosses the signal line it indicates a strong market.

Stochastic Oscillator - indicates the strength or weakness of a market by comparing a closing price to a price range over a period of time. When the stochastic is above 80 it indicates the currency is overbought while a stochastic below 20 indicates the currency is oversold.

Relative Strength Indicator (RSI) - is a scale of 100 indicating the highest and lowest prices over a given period. When the price rises above 70 it is considered overbought and when the price falls below 30 it is considered oversold.

Moving Average - is the average price for a given time interval when compared with other prices during similar time periods. For example, the closing prices over a 3 day period would have a moving average of the total of the 3 closing prices divided by 3.

Bollinger Bands - are bands which contain the majority of a currency’s price. The bands are three lines - the upper and lower lines following the price movement and the middle line showing the average price. During times of high volatility the distance between the upper and lower bands widen. If a bar or candlestick touches one of the bands it indicates overbought or oversold conditions.