Technical Analysis is the method of market analysis that measured only from the market data numbers. The main idea behind Technical Analysis is the postulate of functional dependence of the future market technical data on the past market technical data. The Technical Analysis provides information for the current Forex market quantitatively and more realistic on the chart.
Traders able to forecast the market movement through signals generated from the technical tools itself. In fact, there are thousands of technical methods used around the world of traders and we are going to brief you with some of the most popular tools. Basically, Technical Analysis can be categorized into several classes such as Chart Analysis, Line Study and Technical Indicators which compiled from the market data with specific formulas.
There are 3 types of most commonly seen chart in the Forex platform; the Line chart, Bar chart, and the Candlestick chart. Candlestick chart is able to provide various messages of the market when the chart posture several patterns. Traders may be able to catch the signal within and ready for the upcoming trend.
Economic indicators are reports published at a fixed time intervals by government and private organizations. Economic indicators illustrate the detail of a country's economic performance whether it has improved or reduced. This economic statistics are analyzed to predict the movement of the Forex trading market. An economic indicator that shows a strong country's economy circumstance will enhance the currency exchange rate to rise. Every economic indicator does not have the similar impact on the market every time.
A line chart as shown below is the simplest form of chart. It is plotted by connecting all the closing prices for selected period. But, the chart itself is unable to provide any signal of trading.
A bar chart is shown below consisting information of open, close, high and low price. It is a more advanced chart compared to the line chart as it provides more information within.
The high price in the price bar structure is the highest price of the particular bar time period while the low price is the lowest price. The structure of a price bar is shown below.
The candlestick chart as shown below was developed in Japan around 1750. The candlestick chart is just like the bar chart, it also consists of 4 major prices: high, low, open, and nearby. Though, candlestick chart has graphic format which is easier to interpret and read. Candlestick chart is easier to recognize the market reversal trends. Therefore, candlestick chart is the most generalized chart in use.
The body of the candlestick bar as shown is the spectrum of opening and closing price. It consists of the body with shadows. Usually, a green body is indicating a net rise bar while red body indicates the inverse. But, it may differ from every trading platform or traders are free to use any colors they preferred.
The support and resistance level is a widely use analysis in Forex trading. The peaks represent the price levels where the selling pressure exceeds the buying pressure and they are referred to as resistance levels. On the other hand, represent the levels where buying pressure exceeds the selling pressure and they are referred to as support levels. These resistance and support level provides the traders the general value of the currency and more buying or selling power needed in order to breakout the level. It is usually happened with the boost of significant news.
A trend shows the direction of the market. A trendline is the natural development in tracking a trend which is a straight line that connects the drastic peaks or the drastic troughs. Thus, a trend could be noticed in the chart. The trendlines are classified into up trendlines, down trendlines, and sideways trendlines.
Elliott explained that the upward and downward swings of the mass psychology always showed up in the same repetitive patterns, which were then divided into patterns he called "waves". He needed to claim this observation and so he came up with a super original name: The Elliott Wave Theory. He claimed that a trending market moves in a 5-3 wave pattern. The first 5-wave pattern is called impulse waves and the last 3-wave pattern is called corrective waves.
Usually, a Fibonacci retracement level was used as support and resistance levels. Since so many traders watch these same levels and place buy and sell orders on them to enter trades or place stops, the support and resistance levels become a self-fulfilling expectation. On the other hand, Fibonacci extension levels act as profit taking levels. Again, since so many traders are watching these levels and placing buy and sell orders to take profits, this tool usually works due to self-fulfilling expectations.
*** Aside from those mentioned above, there are still many line study method used widely around the world, there are Symmetrical Triangle, Head and Shoulder, Pivot Point, and lots more which will not be discussed further.
Now we moved from chart interpretation to the quantitative trading formulas which provide more goal view of price task. The tool of the quantitative trading formulas and the technical indicator is a result of mathematical calculations based on indications of price and/or volume with the present or past data. The values acquired are used to forecast possible market changes. Next, we will discuss some of the most commonly used technical indicators.
Moving averages is one of the oldest and most generalized technical exploration tools. It is an average price of a financial instrument through a given time period. As shown in figure 8, the line is smoother if longer time period is used. There are 3 types of moving averages:
The basic moving average is calculated by summing up the prices of instrument closure over a definite number of single periods; whereas the difference with linearly weighted moving average is this form of moving average assigns more weight to the more recent closing prices while SMA use equal weight to each closing prices. For EMA, it takes account of the preceding price information furthermore of assigning different weights to them. Traders can use different time period of moving average such as short-term, medium-term, and long-term periods.
The Bollinger Bands indicator as shown below is a widely used technical indicator which is based on a pair of upper and reduces bands produced from definite standard deviations away from a moving average middle line. Since standard deviations is a choice of volatility, the bands size of the indicator will be widen when volatile while it will be contracted when less volatile period. As a result, the prices are probable to prevail between the best and bottom line of the bands.
Overbought situation is probable to be observed when the price reaches the upper bands and a reverse of trend may happen. Besides, a continuation of a powerful current trend is expected if the prices break by means of the bands. In addition, Bollinger Bands can clearly identify the price movement routine. The small bands width reflects a range-bounce price routine whereas large bands width shows a trending price routine.
Moving Average Convergence-Divergence (MACD) is one of the simplest and most effective momentum indicators available. MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. MACD fluctuates between zero lines as the moving averages converge, cross and diverge. Traders able to look for signal line crossovers, centerline crossovers and divergences to generate buy or sell signals. MACD is making new lows while the exchange rate fails to reach new lows. Both of these divergences are most significant when they occur at overbought or oversold levels.
RSI is a generalized oscillator that chooses the relative strength between upward and downward movement in a specified time frame. RSI is a price going after oscillator and ranges between 0 - 100. As shown in figure 12, the 30 and 70 levels are used as alert signals. Values above 80, indicates an overbought situation and below 20 indicates an oversold situation. If the market has equal strength of upward and downward movement, then the RSI will be at level 50.
Upward strength is stronger when RSI > 50 and downward strength is stronger when RSI > 50. Another generalized method of analyzing the RSI is to seek for a divergence, in which the exchange rate is making a new high, but the RSI is failing to surpass its preceding high. This divergence is an indication of an impending reversal. Therefore, RSI is a favorite indicator that used to resolve overbought and oversold condition and also a cool trend confirmation tool.