Forex Charting 101
Technical analysis is probably the most commonly utilized means of decision making and analysis in the foreign exchange market.
Technical analysis and fundamental analysis are very different. Unlike fundamental analysis, technical analysis actually ignores the fundamental factors, such as economic conditions and news, and is only applied to the price action of the market. Technical analysis for Forex mostly consists of a variety of Forex technical studies. Each of these studies can be interpreted to generate buy and sell signals or to help predict market direction.
The Trend
“The trend is your friend,” is one of the first things that are often heard in technical analysis. Traders find the prevailing trend to make themselves aware of the general market direction. To identify the long-term trend the daily, weekly and monthly charts are most ideally suited. When the technical trader identifies the overall trend, they will usually begin identifying the trend of their chosen trading timeframes.
Support and Resistance
The points where a chart experiences recurring upward or downward pressure are known as support and resistance levels. The support levels exist at the lows and the resistance levels exist at the highs. When the levels are broken, the generally become the opposite. An example of this would be a support level breaking to the downside. It would often become a new resistance level. In a market that is on the rise, a broken resistance level could become support for the upward trend. Likewise, a support level that is broken in a market that is on the decline could become a new resistance level for the downward trend.
Trend Lines and Channels
If you are looking for simple yet helpful tools to confirm the direction of market trends, you could turn to the trend lines. To draw an upward straight line, you would connect at least two successful lows (however, you would preferably connect more). It is necessary that each successive point on the line be higher than the previous point. The line’s continuation helps to determine the path that the market will move along. An upward trend is a solid way to find support lines and levels. To chart the downward lines you would also connect two or more points. The validity of a trend line is, in part, related to the number of points that are connected.
Moving Averages
To identify the overall trend, moving averages can be very helpful. The moving averages show the average price of a currency at a specific point over a specific period of time. Because they reflect the latest average while still adhering to the same time measure, they are called “moving”.
Moving averages are not perfect. Because they lag the market, they don’t necessarily alert the trader to a change in the trends at the best time. To counteract this issue, it is best to use a short period of time when using moving averages. This makes it more reflective of the recent price action than it would be if you use a longer period. However, the moving averages of short periods are subject to more false trend-change alerts.
As an alternate, the trader can use the moving averages by combining two averages of different periods. When the shorter-term average crosses over the longer-term average, buy signals are usually detected. Likewise, sell signals are detected when the shorter-term average falls below the longer-term average.
Mathematically distinct moving averages have three main types: 1) Simple Moving Average (SMA), 2) Exponential Moving Average (EMA) and 3) Weighted Moving Average (WMA). The EMAs and the WMAs give greater importance to the most recent price data. SMAs give equal importance to all of the data in the period. Because of these differences, many traders prefer EMAs and WMAs over the SMAs to help counteract the lag in moving average alerts.
Indicators and Oscillators
Indicators and oscillators vary greatly in both their derivation and their usage. The indicators, which can be found right on the candles or price bars, include moving averages, Parabolic SAR, Bollinger Bands and much more. These indicators are usually lagging, providing a historical view of the price action. The indicators can often confirm or provide clues as to the direction of present momentum and past trends.
On the other hand, the oscillators are generally shown separately above or below the price bars. Like the indicators, the oscillators are also lagging. The oscillators are good at revealing oversold and overbought conditions. Because of this, the oscillators are most useful for traders who would like to identify ranging circumstances, rather than trending circumstances. The oscillators include RSI, Stochastics, MACD and more.
Drawing Tools
Other technical drawing tools are, like analysis tools, popular and also varied. Chart drawing tools have a large number of adherents, with several different versions of Fibonacci formations, Andrew’s Pitchfork, the Gann Fan and much more. Many of these analyses are used to reveal areas of importance, such as the support and resistance levels. The most basic drawing tools are the trend lines, regardless of whether they are diagonal or horizontal. Beyond the trend lines, the drawing tools become increasingly complex and are often created from complex mathematical foundations.