INTRODUCTION TO TECHNICAL ANALYSIS Editor Matthew Carstens WWW.COM FOREX TRADING GUIDE 1 INDEX The lnvesting.com education center was created in order to serve as a guide to the novice trader over all the essential aspects of foreign exchange, in a fun and easy-to-understand manner. General Understanding Basic Assumptions. 4 The Necessity of Technical Analysis. Common Chart Types Line Charts.
Trends and Ranges Trading Trends. Chart Formations & Patterns Symmetrical Triangles. 26 Head and Shoulders. 28 Reverse Head & Shoulders.
30 Chart Formation Highlights. Fibonacci Fibonacci Retracements Illustrated. 35 2 INTRODUCTION TO TECHNICAL ANALYSIS WWW.COM Fibonacci Extensions. 40 Fibonacci Extension Price Targets.
Moving Averages Simple Moving Average (SMA). 45 Exponential Moving Average (EMA). Chart Indicators Bollinger Bands. 49 The Bollinger Bounce.
50 The Bollinger Squeeze. 52 Moving Average Convergence/Divergence (MACD). 57 The use of Parabolic SAR. 58 Relative Strength Index (RSI).
60 Utilizing the RSI. Elliott Wave Theory The 5-3 Wave Pattern. 64 Waves within Waves. Pivot Points Pivot Breakout Trade.
Chart Time Frames Long Term / Position Trader. 72 Short Term / Swing Trader. 72 Intraday / Day Trader. 73 Time Frame Chart Examples.COM INTRODUCTION TO TECHNICAL ANALYSIS 3 General Understanding General Understanding The Primary objective of this guide is to equip you with the prerequisite knowledge needed when analyzing technical trends in the Forex market, and help educate you about a number of the most popular technical trading tools which can help you enhance your Forex investment decisions.
technical Analysis uses past economic data to forecast future price levels. Before trading in the markets, it is essential that all Forex traders equip themselves with such knowledge. Forex Analysis can be classified under two categories: • Fundamental • Technical Fundamental Analysis Forecasts price levels in the currency markets by analyzing economic and political data and scenarios in an effort to predict which currency may gain strength or weakness versus another over time. Technical Analysis Forecasts market trends usually with chart analysis to forecast price fluctuations in different currency markets.
This guide will examine the principles of technical analysis and some of the tools that are used for such analysis. Basic Assumptions Technical analysis is based on three main assumptions: • In technical analysis, we are not necessarily focused on the reasons for any political instability or the reasons for an economic crisis rather we are more interested in watching how price levels change based on economic or political events, and then how the price behaves relative to price levels of the past. • Major currency rates have been shown to form noticeable patterns over time. Technical analysis attempts to forecasts these patterns as a means to help set risk parameters, or find profit opportunities for the trader.
4 INTRODUCTION TO TECHNICAL ANALYSIS WWW.COM General Understanding • Technical Analysis can be very subjective as pattern recognition, wave counts, overbought/oversold indicators or even trend lines are almost never agreed upon as a whole. These tools should be used as a guide, or just one tool out of many, in helping a trader make their trading decisions. The Necessity of Technical Analysis The majority of Forex traders nowadays rely a great deal on technical analysis and fundamental analysis for formulating their trading strategies. The main advantage of technical analysis over the fundamental analysis is that it can be used for diverse market sectors and currencies simultaneously.
Whereas fundamental analysis usually requires complete comprehensive details about the political and economic scenario of a particular country and as such traders will find it difficult to accumulate knowledge of more than a handful of countries at a time. Novice traders may initially be turned off by the complexity of technical analysis. However, every long term successful trader understands the need of a trading strategy, and Technical Analysis has proven to be a reliable tool for predicting price movements in Forex to help formulate trading strategies for years. Nevertheless, it cannot be taken as 100% correct as there are many factors which affect currency prices.
It is for this reason that most traders use an amalgamation of fundamental and technical analysis to help them formulate their trading strategies. Accessibility All online Forex brokers should provide access to an extensive variety of technical analysis charts. There are charting softwares which are free and also detailed professional charts which require a monthly subscription. These charts are updated in real time and provide several options for the user to view price movements and the different patterns that they may form.
Your broker might provide these charts on their website or may include downloadable charts as part of the trading software they provided to you. Before venturing into live Forex trading, it would be wise to get familiar with market trends by analyzing price changes and price levels using your charts for a while. You should try to take note of their fluctuations and see if you notice any patterns developing. You can do this through practice accounts which are usually provided by brokers for novice traders to trade in with no real money transacted.COM INTRODUCTION TO TECHNICAL ANALYSIS 5 General Understanding By using these practice accounts, you will be able to: • Get acquainted with Forexcharts and market trends • Familiarize yourself with the trading softwares which the broker uses.
6 INTRODUCTION TO TECHNICAL ANALYSIS WWW.COM Common Chart Types Common Chart Types Charts provide details about Forex price fluctuations during a specified period of time. The specified time period can range from a minute to a few years. These prices can be charted on simple line graphs or the price fluctuations can be depicted with Bar charts or Candlestick charts. Line Charts Line charts provide you with an overall picture of the price fluctuation during a particular period of time.
Although they may not have the details which are shown in a Bar or Candlestick charts, their simplicity makes them easy to read and to spot trends. They are just depicted by a simple line connecting one market closing price to the subsequent closing price. Below is an example of a simple line chart where you can see price on the Y-axis and time on the X-axis: WWW.COM INTRODUCTION TO TECHNICAL ANALYSIS 7 Common Chart Types Bar Charts Bar Charts provide you with much more details than the simple Line-Charts. The length of the bar denotes the price spread (or movement) within a specific time period.
If there is a big difference between the high and low prices within that time period, this would be indicated by a long bar. The opening price of this time period is denoted by the left tab while the closing price is denoted by the right tab of the bar. Thus, you can immediately see the direction of the price movement (up or down) as well as how much the price moved within that time period. These charts depict the Open, High, Low and the Closing price of the particular currency and as such they are also normally called OHLC chart.
An example of a price-bar is displayed in the figure below: The figure below depicts an example of a bar chartwhere you can see price on the Y-axis and time on the X-axis: 8 INTRODUCTION TO TECHNICAL ANALYSIS WWW.COM Common Chart Types Candlestick Charts Candlestick charts are a Japanese invention used for evaluating rice contracts. Candlestick charts resemble bar charts in many ways as they also show the Open, High, Low and Close prices of a specific period. Comparatively, they are far easier to read than bar-charts as they form a wide body between the Open and Close price in a time period which can be colored in to show upward or downward price movement by time period. • Green or white color candlesticks depict increasing prices.
• Red or black color candlesticks depict decreasing prices.COM INTRODUCTION TO TECHNICAL ANALYSIS 9 Common Chart Types In the example below where the body has been filled in with black, the opening price is shown by the top of the body while the closing price is denoted by the bottom of the body. This signifies that during this time period the price declined in value. If the body was instead White then it means that the closing price is higher than the opening price and an increase in value. Corpo reale 10 INTRODUCTION TO TECHNICAL ANALYSIS WWW.COM Common Chart Types You will also hear of the term “wick”, which of course draws its name from a standard candle wick you’d see on a birthday cake.
The wick signifies the price range the asset moved through during a period of time but did not open or close at (the Body). It signfifies areas where buyers and sellers once battled at.COM INTRODUCTION TO TECHNICAL ANALYSIS 11 Common Chart Types An example of a candlestick chart is shown below. Here “White” is represented by the color Green while “Black” is represented by the color Red. Candlestick Patterns Candlesticks when seen in comparison with adjacent candlesticks may offer an indication of possible market changes that can also assist in chart analysis.
There is an entire school of thought on the recognition and use of these, though they can offer insights on continuation patterns and market reversals on a particular asset. As noted above, the shapes of candlesticks are determined by the Open, High, Low, and Close of a particular asset in a particular time frame. So within that time frame you are actually able to witness the battle between both the buyers and sellers that can give you clues as to what price action may happen next. 12 INTRODUCTION TO TECHNICAL ANALYSIS WWW.COM Common Chart Types Here are a few examples of some popular ones, their fancy names, and how they are most commonly used.
Engulfing This pattern clearly shows that sellers (shown in Black) are in control in the time period on the left but are not able to make any drastic moves (hence the small candle), then on the next time period a much larger formation occurs where a bullish (shown in White) candle completely “engulfs” the Black candle with its entire body. This is a very good indication that Bulls are now in control and upward pricing pressure is probable. This pattern of course works in the opposite way, where a Bearish candle engulfs a smaller Bullish one. Hammer or Shooting Star This pattern shows that buyers opened in this time frame near the high of the candle, and for some reason lost a lot of ground as prices went down quite a bit thereafter.
Interestingly though, is that during this same time frame the buyers fought back and actually closed higher than when they started. This is a very powerful signal that whatever weight the sellers had has been used up as Bulls are clearly in control. This pattern also works in the opposite direction where the body is at the bottom (Sellers win) and the line (also known as the “Wick”) is above it.COM INTRODUCTION TO TECHNICAL ANALYSIS 13 Common Chart Types Harami The Harami draws a lot of similarities to the Engulfing patterns except whereas the Engulfing Patterns shows a clear winner between Buyers and Sellers with momentum in its favor, the Harami shows that the momentum is lost and there is still no clear winner between the buyers and sellers. When this pattern is seen, price direction may be shifting, or consolidation is occurring before another decisive move takes place.
Caution should be on your mind here. Piercing or Dark Cloud Cover This pattern shows how market sentiment can change quickly in just two time frames. The candle on the left clearly shows bears in control and a lot of momentum. On the next candle, the exact opposite occurs, even though the day opened lower than the previous close.
The day closed almost at the high of the previous day, showing that bullish momentum is back in play.