Charts, charts, charts. When most people think about trading
Forex, they think about watching price movements flash by them on the charts
and making money as they jump in and out of profitable trades. This is where
traders show whether or not they have what it takes to be successful in Forex
market.
Technical analysis, or chart reading, is the next natural step
available after you have conducted your fundamental analysis. Fundamental
analysis helps you determine whether you should trade a particular currency pair.
Technical analysis helps you determine when you should buy or sell that
currency pair.
Many traders consider technical analysis to be somewhat of an art
form that anyone can master with a little time and practice. To get started,
you should focus on becoming comfortable with the following foundational
concepts of technical analysis:
Trends—Where prices may be going
Support and Resistance - Where prices may stop and turn
around
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TRADING WITH THE TREND
The key to making money in Forex is identifying trend and trading
with it. Trends tell you where prices will most likely be going in the future.
If the trend of a currency pair is pointing up, you need to buy the currency
pair to make money. If the trend of a currency pair is pointing down, you need
to sell the currency pair to make money. If the trend of a currency pair is
pointing sideways, you either need to alternate between buying and selling or
wait until the trend points up or down to make money. Whatever you do, never fight
the trend. It will be an expensive battle if you do.
Trends do not move straight up or straight down. They usually move
in one direction for a while and then retrace part of the previous movement
before turning back around and continuing on the previous direction. Every time
a currency pair turns around and begins moving in the opposite direction, it
forms a new high or a new low. New highs form when a currency pair moves higher
and then turns around and moves lower. New lows form when a currency pair moves
lower and then turns around and moves higher. Identifying these highs and lows
allows you to identify whether a currency pair is in an uptrend, a down trend
or a sideways trend.
Up trends—currency
pairs that are trending upward form a series of higher highs and higher lows.
Down trends—currency
pairs that are trending downward form a series of lower highs and lower lows.
Sideways trends—currency
pairs that are trending sideways form a series of highs that are at approximately
the same price level and a series of lows that are at approximately the same
price level.
Trends—whether they are up trends, down trends or sideways trends—can
form over various time periods. Identifying the following trends over each time
frame and being able to align them in your analysis is crucial to your success
as a Forex investor:
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Long-term trends
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Intermediate trends
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Short-term trends
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Aligning trend time frames
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Long-Term Trend
Fundamental factors are the major drivers of a currency pair’s
long-term trend. Now that you understand the impact interest rates have on an
economy’s currency, you are already one step ahead of the competition. You’ll
learn even more about the fundamental factors that drive long-term trends in
later sections. For now, all you need to focus on is how to appropriately
identify long-term trends.
Long-term trends, sometimes
called major trends, are those trends that have dominated a currency pair for
the longest period. Looking at this chart of the EUR/USD, you can see that the
currency pair has been rising inan up trend from left to right—notice the
series of higher highs and higher lows as time progressed. Seeing this price
action should give you a bias toward buying the EUR/USD. If the currency pair
had been in a long-term downtrend, you would have a bias toward selling the
EUR/USD.
Next, you need to look at the intermediate trend to see if it is
trending in the same direction as the long-term trend.
Intermediate Trend
Intermediate trends, sometimes called minor trends, are more
responsive than long-term trends because they cover a shorter period of time.
These trends are also affected by fundamental factors. However, interest rates
do not dominate intermediate trends like they do long-term trends. Other
fundamental factors carry equal weight in their affect on intermediate trends.
Looking at this chart of the EUR/USD, you can see that the currency pair was in
a sideways intermediate trend during the highlighted time frame—notice the
series of level highs and level lows as time progressed.
Notice that while the intermediate trend was moving sideways, the
long-term trend was still moving upward. Trends tend to move in a stair-step
fashion. Rarely do they move straight up or straight down.
Seeing this price action should confirm your bias toward buying
the EUR/USD. However, it should also tell you that while your bias is bullish
(you think the currency pair is going to move higher), you may want to wait to
buy the currency pair until you see the intermediate trend move upward—in line
with the long-term trend.
Next, you need to look at the short-term trend to see if it is
trending in the same direction as the long-term trend and the intermediate
trend.
Short-Term Trend
Short-term trends, sometimes
called micro trends, are more responsive than both long-term trends and
intermediate trends because they cover the shortest period of time. These
trends are the most volatile trends and are predominantly affected by the news
of the day. It is not uncommon to see these short-term trends change direction
extremely rapidly. Looking at this chart of the EUR/USD, you can see that the
currency pair was in a down-trending short-term trend during the highlighted
time frame—notice the series of lower highs and lower lows as time progressed. Notice
that while the short-term trend was moving downward, the intermediate trend was
still moving sideways and the long-term trend was still moving upward. It is
possible to have each trend moving in a different direction, as you see here.
Seeing this price action should alert you that you may have to
change your bias toward buying the EUR/USD in the future. However, since it is
the only the short-term trend, you should not abandon your bullish convictions
toward the EUR/USD just yet.
In this example, the long-term, intermediate and short-term trends
for the EUR/USD are in conflict. You should not trade when the trends are in
conflict. Instead, you should wait until you can align the trends from each
time frame.
Aligning Trend Time Frames
Your most profitable trading opportunities will come when the
long-term, intermediate and short-term trends all line up in the same
direction. When the long-term, intermediate and short-term trends are all
moving higher, it is an excellent time to buy the currency pair. When the
long-term, intermediate and short-term trends are all moving lower, it is an
excellent time to sell the currency pair.
You can see in the chart of the EUR/USD that the trend for each
time frame has been moving higher for the past few months, and the EUR/USD has
shot higher. Had you purchased this currency pair and held it through this most
recent rally, you would have made a large profit.
Understanding trends is only half of the basic technical analysis
picture. To complete the picture, you also have to understand the concepts of
support and resistance.
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Paying Attention to Support and Resistance
You will increase your trading profitability if you can accurately
identify levels of support and resistance—areas where prices may stop and turn
around in the future. Knowing where a currency pair may stop and turn around
helps you enter and exit your trades at the most profitable times
.
Support is a
price level at which a currency pair tends to stop moving down and then turns
around and starts moving back up.
Resistance is a
price level at which a currency pair tends to stop moving up and then turns around
and starts moving back down.
Support and resistance levels are not precise price points.
Rather, they are general price ranges. For example, you are only going to
frustrate yourself if you try to pinpoint a price level of 1.4225 on the EUR/USD
as support. You will be much better off if you identify a price range of 1.4210
to 1.4240 or 1.4220 to 1.4230 as support. Give your support and resistance
levels some room to be flexible.
You will find that support and resistance levels come in varying
forms. To become a successful Forex investor, you will need to learn to
recognize the following:
Horizontal
Support and Resistance
Diagonal Support and Resistance
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Horizontal Support and Resistance
Horizontal support and resistance levels are perhaps the easiest
levels to identify. As you look at the charts of the currency pairs you are
interested in trading, you will begin to notice that the currency pairs will
often rise and fall to the same price levels before turning around and moving
back in the opposite direction. These price levels are horizontal support and
resistance levels.
Looking at the EUR/USD chart,
for instance, you can see that certain price levels (indicated by bold orange
lines) acted as strong levels of support and resistance. During nov-Dec 2010,
the EUR/USD bounced back and forth between a support level at about 1.2850 and a
resistance level at about 1.3470. Imagine you had bought the EUR/USD at 1.2990
as it was bouncing off of support and it was now approaching 1.3470. Knowing
that this level has been a significant resistance level, you may consider
exiting your EUR/USD trade so you can realize your profits before the currency
pair turns around and begins moving lower.
Once you feel comfortable identifying horizontal levels of support
and resistance, you can move on to diagonal levels of support and resistance.
Diagonal Support and Resistance
Diagonal support and resistance levels can be more difficult to
identify when you are just getting started. However, diagonal support and
resistance levels are usually the most important levels when you are analyzing
a currency pair that is trending. Remember, you want to find trending currency
pairs because it is much easier to make profitable trades when a currency pair
is trending.
As you look at the charts of the currency pairs you are interested
in trading, you will begin to notice that the currency pairs will often rise
and fall in a stair-step pattern. These patterns form higher highs and higher
lows or lower highs and lower lows. The lines that connect these highs and lows
are your diagonal support and resistance levels.
Looking at the EUR/USD chart, for instance, you can see that the
currency pair was creating a series of higher highs and higher lows through
most of Nov 2010 and Jan 2011. If you connect all of the highs with a diagonal
line and all of the lows with another diagonal line (indicated by bold red
lines) you will be able to see the diagonal levels of support and resistance
that are affecting the EUR/USD.
If you were watching the EUR/USD, you would wait until you saw the
currency pair drop down to the uptrending support level before you bought it.
Once you were in your trade, you could then watch for the EUR/USD to climb up
to the uptrending resistance level before you exited the trade and took your
profits.
The real trick to effectively investing using support and
resistance levels is to combine both horizontal and diagonal levels in your
analysis. Your currency charts have a wealth of information locked within them,
and they are waiting for you to unlock that information with simple, but
effective, technical analysis techniques.
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