TECHNICAL ANALYSIS
Introduction to Technical Analysis
Technical Analysis, is a method used for analysis and
forecasting the direction(rise or fall) of prices through the study of recorded
price data, often in form of charts.
This price data for the currencies is provided by your
broker through the trading platform.
The Forex charts contain the candlesticks.
You can add indicators and other objects in the charts to
help you to analyse the Forex price action.
For Technical Analysis, I will take you through the six main
pillars of this type of analysis.
These are:
- Trend.
- Support
levels.
- Resistance
levels.
- Chart
patterns.
- Candlestick
shapes and patterns.
- Indicators.
Trend
A trend is a tendency for prices to move in a particular
direction. That is either up or down.
The two types of trends are:
- Uptrend.
- Downtrend
Let’s start with an uptrend
Uptrend
In this example, you are looking at the US Dollar, Swiss
Franc pair.
The US Dollar is the Base currency and its price is rising
against the Swiss Franc.
Here, we say that the US Dollar is in an uptrend.
We should only think of buying, not selling in an uptrend.
So, if you see that a currency pair is in an uptrend, should
you go and buy it right away?
Well, no!
There will be an article where I will guide you on how to
enter trades.
Let’s now go to a downtrend.
Downtrend
For a downtrend, the price of the Base currency is consistently
going down.
In this example, you can see that the price of the Euro is
falling against the US Dollar.
For such a case, you should only think of selling, not
buying.
Consolidations in the Forex Charts
But wait, do currency pairs trend all the time?
The simple answer is no!
In this example, you can see that the pair is not trending.
As traders, we say that that currency pair is consolidating
within a range.
In this case, do you buy or sell.
Well, to trade a pair that is consolidating, you need to
understand the concept of support and resistance.
Support levels in the Forex Charts
Support levels, are also known as demand zones.
A support level, is a price level in the forex chart where
there are more buyers than sellers.
You recognize a demand zone, if the price of the base currency rises more than
one time whenever it gets to that price level.
In the example above, you can see that the price of the US
Dollar keeps rising repeatedly whenever it gets to that support level.
In that support level, you should think of buying because
you expect the price to rise.
Resistance levels in the Forex Charts
Resistance levels are also known as supply zones.
A resistance level is a price level in the forex chart,
where there are more sellers than buyers.
You recognize a supply zone, if the price of the base currency falls more than
one time whenever it gets to that price level.
In the example above, you can see that the price of the US
Dollar keeps falling repeatedly whenever it gets to that resistance level.
In that resistance level, you should think of selling
because you expect the price to fall.
Chart Patterns
A Chart Pattern is a shape formed within the price chart by
many candlesticks that help to suggest what prices might do next.
Some chart patterns are important because when they occur,
prices tend to behave in a particular manner.
There two major categories of Chart Patterns.
These are:
- Trend continuation patterns.
We will look at the major two.
2.
Trend reversal patterns.
We will look at the major four.
Trend Continuation Chart Patterns
Bullish Rectangle
The first trend continuation pattern is a bullish rectangle.
It shows the continuation of an uptrend.
The bullish rectangle is an area of consolidation during an
uptrend, and the uptrend continues.
You can see that in this Swiss Franc, Japanese Yen chart.
Bearish Rectangle
The second trend continuation pattern is a bearish
rectangle.
It shows the continuation of a downtrend.
The bearish rectangle is an area of consolidation before the
continuation of the downtrend.
Trend Reversal Chart Patterns
Double Bottom Chart Pattern
The first trend reversal chart pattern is the double bottom
chart pattern.
It shows the reversal of a downtrend to form an uptrend due
to a very strong support level.
Double Top Chart Pattern
The second trend reversal chart pattern is the double top
chart pattern.
It shows the reversal of an uptrend to form a downtrend due
to a very strong resistance level.
Head and Shoulders Chart Pattern
The third trend reversal chart pattern is the head and
shoulders chart pattern.
It shows the reversal of an uptrend to form a downtrend due
to a very strong resistance level.
Inverse Head and Shoulders Chart Pattern
The fourth trend reversal chart pattern is the inverse head
and shoulders chart pattern.
It shows the reversal of a downtrend to form an uptrend due
to a very strong support level.
The important candlestick shapes and patterns
Candlestick shapes and patterns can be used to predict price
movement, but you should not use them alone.
Candlestick Shapes and Patterns that give a buying signal
The candlestick pattern on the left is the bullish engulfing
pattern.
It shows increased buying pressure due to the large green
bullish candle, compared to the small red bearish candle.
The candlestick shape on the right is the hammer candle,
also known as the bullish pin bar.
It shows increased buying pressure, because the sellers had
pushed the prices down but the buyers came in later and pushed the price up,
which is shown by the long lower candle-wick.
Candlestick Shapes and Patterns that give a selling signal
The candlestick pattern on the left is the bearish engulfing
pattern.
It shows increased selling pressure due to the large red
bearish candle, compared to the small green bullish candle.
The candlestick shape on the right is the shooting-star
candle, also known as the bearish pin bar.
It shows increased selling pressure, because the buyers had
pushed the prices up but the sellers came in later and pushed the price down,
which is shown by the long upper candle-wick.
The major Forex Indicators
Indicators help traders in analysis of the Forex
Charts.
They are derived from the prices already shown in the
Forex Charts.
The major
indicators used in Forex Charts are:
- The Moving Average
- The RSI indicator
- The ATR indicator
You don’t have to use all of them, or even any.
Adding an indicator in the Forex
Charts
To add an
indicator in the Forex Charts, tap the f function sign in the Charts Tab
of MetaTrader 4.
The Moving Average Indicator
The first indicator, is the Moving Average.
When adding the Moving Average Indicator, set the period to
be 50, as it will calculate the average closing price of the last 50 candles.
It is the best for spotting trends.
The major function of the moving average indicator is to
help you easily identify trends.
In the USDCAD example above, you can see that the price is
staying above the 50 Moving Average, so this will be considered as an uptrend.
In this EURUSD example below, the price is staying below the
50 Moving Average, so this will be considered as a downtrend.
The RSI Indicator
The second indicator, is the RSI Indicator.
RSI in full, is Relative Strength Index.
The RSI Indicator is an oscillator that shows overbought and
oversold areas in the Forex Chart.
It oscillates from a value of 0 to 100.
If the RSI is above 70, it means that the market is
overbought and if it is below 30, it means that the market is oversold.
If a currency is overbought, it means that its price has
rose quickly within a short time, and the price is likely to go down afterwards.
But you should not sell in an uptrend, simply because the
RSI says that the market is overbought. The same goes for buying in a
downtrend, simply because the RSI says oversold.
The ATR Indicator
The third indicator, is the ATR Indicator.
ATR in full, is Average True Range.
The ATR Indicator is used to measure the volatility of a
currency pair.
It measures volatility by calculating the movement of pips.
So, the higher the volatility, the higher the reading.
Trading should be done when the volatility is neither too
high, nor too low.
Very high volatility is only good for scalpers.
Also, some currency pairs are generally more volatile than
others.
For example, the British Pound against the Japanese
Yen(GBPJPY) is very volatile. So, I don’t recommend beginners to trade it.
The currency pair that I recommend for beginners is the
EURUSD pair, because it is moderately volatile and the spreads are very low.
But you can still trade other pairs if you spot good trading
opportunities.
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