Forex trading Technical analysis
Technical analysis is grounded in the notion that price data alone is all that is
needed to forecast future price movements. While simple, in theory, technical
analysis is extremely complex in practice. There are dozens of basic
technical trading strategies, incorporating hundreds of tools and thousands of
different iterations. To master (let alone attempt to utilize) more than a
handful of these tools would be unrealistic or even counterproductive.
Accordingly, in the sections that follow, I have tried to pare down the vast
the spectrum of technical analysis strategies into a manageable number, with an
emphasis on those that are easy to use, quantitative, and compatible with
A trader’s best friend is his chart, and this is especially true for technical
traders. With time on the x-axis and price on the y-axis, a chart is the most
basic visual representation of the historical exchange rate performance for a
given currency pair. If only it were that simple! One must first select the
chart type, variously depicted in images. Line charts and area charts
connect individual price points over a given period of time. Technical traders
prefer bar or candlestick charts—which show opening, closing, high, and low
In fact, there is a branch of technical analysis devoted to the study of
candlestick formations, with a system of Japanese nomenclature to boot.
Individual formations can be
interpreted as being bullish, bearish, or stable, and a series of formations can
potentially indicate good times to buy and sell. Alas, candlestick analysis is
exceedingly intricate, and it extends beyond the scope of this book. For those
of you interested in learning more, I would recommend consulting one of the
numerous books that have been written about the subject.
Best Profit Chart Patterns for Trading
Anyway, the next step in setting up a chart is to select the overall time frame
(e.g., one year, one month, one day, one hour) and the unit of time (e.g., one
day, five minutes, one minute). While seemingly trivial, the time frame of
your chart is actually a very important consideration. Different lengths of
time may show different—and sometimes contradictory—trends. Naturally,
it’s best to select a time period that is consistent with your trading horizon. If
you plan to follow the swing trading approach advocated in this book, it
makes sense to look at price data in a 3–12 month time frame. If, in contrast,
you are an aspiring day trader, you probably won’t be able to glean anything
useful from a chart covering anything longer than one week.
In fact, as you can see in the images, selecting the wrong time scale for your
chart could yield disastrous consequences. Specifically, if you bought the
EUR/GBP based on your interpretation of the 30-minute inset chart, you
probably would have lost money on the trade. If you instead had taken the
time to examine a medium-term (five-hour) chart, you would have clearly
“The trend is your friend” is one of the oldest adages in technical analysis.
Without trends, technical analysis would be meaningless and trades would be
random. The goal is to determine whether a currency pair is currently caught
in an uptrend, downtrend, or sideways trend. Profits accrue to those that are
able to anticipate the beginnings and ends of trends and trade accordingly.
The most basic level of trend analysis involves a visual inspection of the
chart. Those with well-trained eyes will immediately notice any trends. It can
also be helpful to draw lines (which most charting software packages enable)
directly onto the chart. You can see from the chart in Figure 6-6, for
example, that there are a handful of trends that seem to both dictate and
delimit movement in the EUR/CHF. Over one and a half years, there were
several medium-term trends apparent to the naked eye. Sometimes, the trends
were so robust that even after sudden upside or downside aberrations, the
original trend was restored. This was the case in September 2011. Other
times, the pair is prevented from falling or rising by support or resistance
lines, respectively. Recall from Chapter 3 that while somewhat arbitrary,
these levels often represent real barriers to momentum in one or both
directions. They tend to form at round numbers, and their existence can be
confirmed when rates (repeatedly) “bounce” off of them upon contact. When
there is both support and resistance, the pair is said to be trading in a channel.
The breaching of the channel walls signals the potential start of a significant
uptrend or downtrend. This phenomenon is known as a breakout.
There are also a handful of shapes and chart patterns that provide guidance
for spotting trend continuations and reversals. Double tops, double bottoms,
head, and shoulders, and other patterns are grounded in the notion that before
a trend reverses, it will usually hesitate and do a slight about-face (or two).
As can be seen in the images, the change in the AUD/JPY from long-term
uptrend to long-term downtrend was heralded by a double top. Other times,
trends will reverse suddenly and squeeze those that are caught on the wrong
side of the trade. These sudden reversals are usually accompanied by a surge
in volume and indicated by a V-formation on the chart. Triangles, wedges,
and pennants, on the other hand, usually imply trend continuation. These
formations are caused when positions are consolidated in the midst of a
strong trend, causing price gyrations to get smaller and smaller until a
continuation becomes inevitable. In this case, we should expect the
Double-top Trading formula
Admittedly, spotting trends is more of an art than a science; hindsight is
20/20. To be sure, drawing crude shapes onto charts may seem a little silly.
Still, the ideas of trends, support, and resistance have strong underpinnings in
human psychology. For example, the crowd mentality and dealer complicity
can turn slight directional momentum into veritable trends. Remember also
that correlation within the financial markets is strengthening, and investor
risk appetite is becoming the dominant driver of asset prices. Frequent
changes in risk appetite are causing prices to slide up and down in
movements that most observers would call “trends.” Finally, support and
resistance can become self-fulfilling, as certain levels become
psychologically important and trigger sudden surges in buying and selling. In
this case, the goal is not to outsmart the market but to simply ride the wave
that others may be creating.
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