THE BEGINNERS GUIDE TO TECHNICAL ANALYSIS
Technical Analysis Introduction
There are two primary methods used to analyse the forex market and make trading decisions:
Fundamental analysis and technical analysis.
Fundamental analysis involves analysing a country's economic data and political news releases to determine the fair value of the countries currency.
Technical analysis assumes that the forex currency price already reflects all publicly-available information and instead focuses on the statistical analysis of price movements.
Technical analysis may appear complicated on the surface, but it boils down to an analysis of supply and demand in the market to determine where the price trend is headed. In other words, technical analysis attempts to understand the market sentiment behind price trends rather than analysing currency fundamental attributes.
If you know the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader over the long-term.
In this beginners guide to technical analysis, you will be introduced to technical analysis and develop the foundation needed to understand more advanced concepts down the road.
There are many different forms of technical analysis. Some rely on chart patterns, others use technical indicators and oscillators, and most use a combination of techniques. In any case, technical analysts’ exclusive use of historical price and volume data is what separates them from their fundamental counterparts.
Unlike fundamental forex traders, technical forex traders don’t concern themselves with a currency’s valuation – the only thing that matters are past trading data and what information the data might provide about future price movements.
Technical forex trading is based on two assumptions:
1. Price Moves in Trends.
Technical traders believe that prices move in short, medium and long-term trend. In other words, forex currency price is more likely to continue a past trend than move erratically. Most technical trading strategies are based on this assumption.
2. History Tends to Repeat Itself.
Technical traders believe that history tends to repeat itself. The repetitive nature of price movements is often attributed to market psychology, which tends to be very predictable based on emotions like fear or excitement.
Technical analysis uses chart patterns to analyse these emotions and subsequent market movements to understand trends. While many forms of technical analysis have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.
There are 3 main forex trading styles.
1. Day trading
2. Swing trading
Day trading (or intraday trading) means taking trade positions during the day and closing those trade positions by the end of the day. Day trading aims to achieve profitability through frequently entering and exiting a market. The main goal of day trading is to achieve long-term profitability through executing as many winning trades as possible. Day traders use small time frames like 5, 10, 15 and 30 min candlestick price charts.
In swing trading, traders use the bigger time-frames like 4hour, daily, weekly and monthly candlestick price chart to enter a trade position. Swing traders have a longer term view on the movement of price. Swing traders will typically hold trade positions for a few days up to a few weeks or even a month or so.
Scalping the forex market is simply taking advantage of the very minor changes in the price of an asset, usually performed over a very short period of time. Most traders scalp currency pairs using a time frame between 1-5 minutes. The main goal of scalping is to make a profit through purchasing or selling currencies by holding a position for an extremely short period of time and closing it for a small profit. The main aspect of Forex scalping is quantity. It is not unusual for traders to place more than 100 trades a day.
What Is A Price Chart?
Charts are at the heart of trading. In addition to helping traders monitor the value of their current positions, they also help traders see where price has been, and in doing so, provide clues as to where price will go. As such, understanding how to read a price chart is a key step in the journey to becoming a trader. charts are available via your forex broker and also bespoke software.
The first concept to understand is that price shows the behaviour of price relative to time.
(insert chart pic )
TIME: X-Axis (Left to Right)
The time component of a price chart is read on the x-axis (left to right). The further left we look, the more into the past we are looking.
PRICE: Y-Axis (Top to Bottom)
The price of an instrument is read on the vertical axis and is indicated by the price line.
What Is A Candlestick Chart?
The 2 most common forms of price chart are:
1. Line Chart
2. Candlestick Chart
While they provide variations of price information, they both share the concept of time (periods). On a candlestick chart, each candlestick represents one unit of time. Price charts typically have a setting that allows you to modify what one unit of time represents. If the timeframe is set to daily, this means that each candlestick represents one day's worth of price activity. If it is set to 5 minutes, this means each candle or bar represents 5 minutes of price activity.
On a candle or bar chart, each unit on the chart shows four elements
OPEN PRICE: This is the price that started the period. The lower part of the body of the candle is the open if the candle is green. If the colour of the candle is red, the high of the body signifies the open.
HIGH PRICE: The highest price traded during that period.
LOW: The lowest price traded during that period.
CLOSE: The price closed at for that period. Colour is used to differentiate between open and close.
At the end of the period, the process repeats itself with a new candlestick. Below is a visualisation of each type of candlestick.
Long, Bullish, Short and Bearish
In forex trading, you buy or go long a currency if you believe its value will increase.
The term "bull" or "bullish" comes from the bull, who strikes upwards with its horns, thus pushing prices higher.
Bullish/bull and long are sometimes used interchangeably. For example, instead of saying "I am long" a trader may simply say "I am bullish". Both indicate that they believe prices will rise.
Most people think of trading as "buy low, sell high." Buy at a low price in the hopes of selling at a higher price later.
You can also "sell high, buy low." Being short, or shorting, is when you sell first in the hopes of being able to buy the asset back at a lower price later.
This is a strange concept for many people to grasp, but in the forex market you can buy then sell, or sell then buy. If you've done the latter, then you're short the asset.
If going short is an action resulting from a belief an asset will drop in value, then being bearish is the belief. A bearish person believes an asset's price will fall.
To say "I'm bearish on the Euro" means a belief that the price of the euro currency will decline in value.
The term "bear" or "bearish" comes from the bear, who strikes downward with its paws, thus pushing prices down.
Candlestick patterns are viewed by technical traders as a form of price direction signal. The following list includes some of the more popular patterns.
A doji occurs when the opening and closing prices are basically the same price, resulting in a very small body. Note that the length of the upper and lower shadows / wick (which reflect the intra-period prices) have no effect on the closing price.
The interpretation of the basic doji is that there is no clear direction for the market. This should make you wary until a stronger indication presents itself.
Dragonfly doji candlestick
Formed when the opening and the closing prices are at the highest of the day. Dragonfly Doji candlesticks that have a long lower shadow can signal a buy trade bias. When appearing at market bottoms it is considered to be a reversal signal.
Gravestone doji candlestick
Formed when the opening and closing prices are at the lowest of the day. Gravestone Doji candlesticks that have a long upper shadow can signal a bearish trade bias.When it appears at market bottom it is considered a reversal signal.
A black or a white candlestick that consists of a small body near the high with a little or no upper shadow and a long lower tail. Considered a bullish pattern during a downtrend.
Inverted Hammer candlestick
A black or a white candlestick in an upside-down hammer position.
Support & Resistance
Support and resistance levels help technical traders recognise areas on a chart where an asset’s price movement is more likely to either reverse or consolidate into a bigger movement.
A support level is a level where the price tends to find support as it falls. This means that the price is more likely to "bounce" off this level rather than break through it. However, once the price has breached this level, by an amount exceeding some distance, it is likely to continue falling until meeting another support level.
A resistance level is the opposite of a support level. It is where the price tends to find resistance as it rises. Again, this means that the price is more likely to "bounce" off this level rather than break through it. However, once the price has breached this level, by an amount exceeding some noise, it is likely to continue rising until meeting another resistance level.
Support and resistance methods are "predictive" in that they often outline areas where price has not actually been. They are based upon historical price levels that, through analysis, has been shown to be predictive of future price action.
If a price breaks past a support level, that support level often becomes a new resistance level. The opposite is true as well; if price breaks a resistance level, it will often find support at that level in the future.
This is an example of support switching roles with resistance, and vice versa:
Resistance switching roles with support:
If price is moving between support and resistance levels, then a basic trading strategy commonly used by traders, is to buy (go long) at support or sell (go short) at resistance.
What is a Trend?
A trend is price behaviour, which involves overall price increasing or decreasing. A currency pair is trending when it is increasing or decreasing for a longer period of time. There are two types of trends in Forex – a bullish (up) trend and bearish (down) trend.
Determine The Trend
A bullish trending market is one where price is making higher highs followed by higher lows
A bearish trending market is one where price is making lower lows followed by lower highs.
One of the simplest and most effective ways to analyse trends is through the use of trend lines. A trend line is an on-chart diagonal line, which connects a number of higher lows in a bullish trend and lower highs in a bearish trend.
If the trend line manages to connect a minimum of 2 higher lows or 2 lower highs, then we expect the price action to conform to this trend line. The primary function of the trendline is to act as a support, or resistance for price on a price chart.
Trend trading is popular in forex because the profits from a trending pair are potentially massive and trades can involve less risk.
Ranges form where the price is constrained between a support area and a resistance area. Price is neither producing higher lows or lower highs. Essentially, price is moving sideways.