Introduction to Technical Analysis – 2

In this second article about FOREX technical analysis we will look at the various kinds of charts and provide basic guidelines for reading charts.

Price Charts

Price Charts show information about FOREX prices at specified intervals of time. Intervals can be from one minute up to several years and everything in between. Prices can be plotted with simple line graphs or the price variation for each interval can be shown by a bar or candlestick pattern.

Line charts are suitable for getting a broad overview of price movements. They show the close price at the chosen intervals. Line charts are very clean to read and make it easy to spot patterns, but they lack the detail of bar and candlestick charts.

Bar charts offer much more information than line charts. The length of each bar indicates the price spread for the given period – a long bar indicates a large difference between high and low prices. The left tab on the bar shows the opening price and the right tab show the closing price. You can see at a glance whether the price fell or rose for that particular period, and what the price variation was. Bar charts printed on paper (especially for short periods) can be difficult to read, but software charts usually have a zoom function that makes it easier to read closely spaced bars.

Candlestick charts were invented by the Japanese for analyzing rice contracts. They are similar to bar charts in that they indicate open, close, high and low prices for a given period. They are easier to read than bar charts, however, because of their color coding. Green candlesticks show rising prices and red candlesticks show falling prices.

Candlestick shapes – when viewed in relationship to neighbouring candlesticks – provide indicators of market movement that can aid in chart analysis. Various shapes of candlesticks are formed according to price spread and the proximity of opening to closing prices. Candlestick patterns have been given fanciful names like ‘morning star’ and ‘dark cloud cover’ and once the shapes have been learned, they are easy to pick out on a chart for identifying trends in the market.

Price charts are usually supplemented with technical indicators. There are many Technical Indicators broadly divided into different categories. Trend indicators, strength indicators, volatility indicators, and cycle indicators are just some of the analytical tools used to anticipate movement and market volume.

Some of the most common technical indicators used in FOREX are:

Average Directional Movement Index (ADX) – is used to determine if a market is entering a trend (either downward or upward) and how strong the trend is. Readings over 25 indicate a trend with higher values indicating stronger trends.

Moving Average Convergence/Divergence (MACD) – shows the momentum of the market and the relationship between two moving averages. When the MACD line crosses the signal line it indicates a strong market.

Stochastic Oscillator – indicates the strength or weakness of a market by comparing a closing price to a price range over a period of time. When the stochastic is above 80 it indicates the currency is overbought while a stochastic below 20 indicates the currency is oversold.

Relative Strength Indicator (RSI) – is a scale of 100 indicating the highest and lowest prices over a given period. When the price rises above 70 it is considered overbought and when the price falls below 30 it is considered oversold.

Moving Average – is the average price for a given time interval when compared with other prices during similar time periods. For example, the closing prices over a 3 day period would have a moving average of the total of the 3 closing prices divided by 3.

Bollinger Bands – are bands which contain the majority of a currency’s price. The bands are three lines – the upper and lower lines following the price movement and the middle line showing the average price. During times of high volatility the distance between the upper and lower bands widen. If a bar or candlestick touches one of the bands it indicates overbought or oversold conditions.

Forex Education

Introduction

Forex education is as imperative for veteran forex traders as it is for novices. Learning to be a successful Forex trader is a constant, unending process. The road to Forex education, therefore, has a start but knows no end. One should not try to deal in the forex markets unless he or she receives appropriate forex education and guidance to become a successful forex trader. There are considerable returns to be made in the forex market, but trading in the Forex is for the educated.

The recent innovations in electronic technologies have made forex education available in ways formerly restricted to the elite market players. The expansion of the Internet and the subsequent mass-scale development of e-commerce have permitted digital trading and forex education obtainable for any person with a processor and access to the web.

Brief History

In the early part of the 20th century, currency markets were comparatively stable. Although diverse currencies and the requirement to trade them had existed for eons, the exchange rates remained steady. Speculative activity rarely occurred, and the colossal speculative action in the Forex market nowadays would have been nightmarish. The chief catalyst to the speeding up of Forex trading and the consequent need for Forex education was the swift growth of the euro-dollar market.

Paramount for Traders

Scores of traders arrive with modest or absolutely no Forex education to the foreign exchange markets, only to squander their entire resources, in just a few days. Reason: These traders were not concerned to learn the fine details of the Forex markets, strategies one should adopt, technical analysis, currency chart systems and a host of other vital things one should be familiar with, before one starts trading. It is imperative for both the experienced and greenhorn traders to have some serious Forex education before they begin dealing in these markets.

Traders Bible

The foreign exchange market is truly one of the most popular marketplaces for speculative activity due to its colossal size, sheer amount of liquidity, and penchant for the currencies to move in rather strong trends. A tantalizing characteristic of trading currencies is the high level of leverage offered. The Forex brokers by and large allow positions to be leveraged up to 100:1.

Without proper Forex education and appropriate risk management, this extremely high level of leverage can result in substantial swings between profit and loss. Forex education teaches us that even veteran traders experience losses, and thus assumptions in the forex market should only be carried out with risk capital funds that, if lost, will not extensively impinge on the traders’ individual financial health.

How to Read FOREX Quotes

Currency prices are determined by a number of factors, the most important of which are economic and political conditions in the issuing country. Political stability, inflation, and interest rates are all factored into the price of any currency. In addition, governments can try to control the price of their currency by either flooding the market (to lower the price) or buying extensively (to raise the price).

Because of the immense volume of FOREX, however, it is impossible for one force to control the market for any length of time. Market forces will prevail in the long run, making FOREX one of the most open and fair investment opportunities available.

Each world currency is given a three letter code which is used in FOREX quotes. The most common currencies are USD (US dollars), EUR (European euros), GBP (United Kingdom pounds), AUD (Australian dollars), JPY (Japanese yen), CHF (Swiss francs) and CAD (Canadian dollars).

Prices of foreign exchange are indicated by FOREX quotes in pairs of currencies. The first currency is the ‘base’ and the second is the ‘quote’ currency. In this example:

USD/EUR = 0.8419

…the currency pair is US dollars and European euros. The base currency (USD) is always at ‘1’ and the quote currency shows how much it costs to buy one unit of the base currency. In this example, 1 US dollar costs 0.8419 euros.

Conversely…

EUR/USD = 1.1882

…tells us that it costs 1.1882 US dollars to buy 1 euro.

When the price of the quote currency goes up it indicates that the base currency is becoming stronger – one unit of the base currency will buy more of the quote currency. If the quote currency falls, however, the base currency is becoming weaker.

FOREX quotes are seen in ‘bid’ and ‘ask’ prices. Bid is the price that buyers will pay for the base currency (while selling the quote currency), and ask is the price that sellers will sell the base currency (while buying the quote currency).

Symbol Bid Ask
USD/CAD 1.2392 1.2397

This chart tells us that we can buy one American dollar for 1.2397 Canadian dollars, or sell one American dollar for 1.2392 Canadian dollars. The most commonly traded currencies pairs are the ‘Majors’ – GBP/USD, EUR/USD, AUD/USD, USD/JPY, USD/CHF, and USD/CAD.

We often see exchange rates listed in cross currency charts that list many different currencies and their values against each other. An example of such a chart is seen here:

US $ Ca $ Euro UK ?
US $ 1.00000 1.24060 0.83935 0.56870
Ca $ 0.80606 1.00000 0.67657 0.45841
Euro 1.19140 1.47805 1.00000 0.67755
UK ? 1.75840 2.18147 1.47591 1.00000

In this chart, the currencies listed down the left side of the chart are the base currencies and the currencies at the top are the quote currencies. We can convert the chart above into currency pairs by following the row beside the base currency. Using US dollars as the base currency we get the following currency pairs:

USD/CAD = 1.24060
USD/EUR = 0.83935
USD/GBP = 0.56870

…which tells us that one US dollar is equal to the corresponding value of the quote currency. To find the opposite pair e.g. CAD/USD follow the Canadian dollar row to the US dollar column – CAD/USD = 0.80606 (one Canadian dollar is worth 0.80606 US dollars).

There is no standard for cross-currency charts – some have the base currency on the top and some have it on the side. How to tell which is which? You need to know at least one pair of currencies and which one of the pair is more valuable.

?The Important Ways to Keep From Losing in the Forex Markets

The idea behind forex trading is of course to make money. However, like any speculative investment, there is a change of loosing money. The same holds true with the stock market and the commodities market, and in business itself. Any investment that has a chance of great gain will also have a certain level of risk. As a forex trader you will want to minimize your chance of risk. Do it in these ways.

Stay informed. Read the news magazines and political events journals. Know what is happening in the world politically.

Have a good understanding of economics. Take a college econ course if you never have. Read the journals of economics and books by economists like John Maynard Keyes, Kenneth Galbraith and Walter Williams.

Read periodicals like the Wall Street Journal and Business Investors Daily.

Open up a practice demo account and use it before you get into the market.

Have a broker you trust.

Cultivate friendships with other traders who know their stuff.

Look at the historical trends. Read and study forex charts.

Take a course in forex trading to get your skills up to snuff.

Research forex on the Internet.

And finally, only invest money that you can actually afford to loose if worse comes to worse. Then you won’t be out of the game completely.

Forex trading is not a game for the timid. Jerry Sparks was a forex trader who did very well for years. He followed all of the rules. His college degree was in history with a minor in political science and he went back and took extra courses in economics and business. Jerry stayed informed. He watched CNN, CNBC, MSNBC and Fox News often. He went to all the major web sites and read several magazines. He also spent time with a demo account before he got into the market in a big way. Jerry was determined to make a killing, and he eventually did. Jerry also only invested money that he had designated as risk capital. He could still live without it if needed.

Sam Franks, Jerry’s friend, didn’t do as well. Sam never took an economics course in his life and in fact was bored by Economics. He knew nothing of history or politics and didn’t even know who John Maynard Keyes was. Sam took his life savings and invested in forex trading without having spent time practicing with a demo account. He knew nothing of the currencies he was trading, and didn’t know what historical trends were, or what activity was occurring. He knew nothing of inflation, and in the end he lost some of his money. The difference in these two people is important. One was prepared and the other was not prepared. One made money and the other did not. One did his homework and one neglected it. What you can learn from this is that it is better to be prepared.

By knowing something about other countries and the activities happening over there, you’ll be better able to make educated guesses. For instance, if there is a great deal of inflation in a country, you may not want to invest in its currency. However, if you are hedging against that currency you may do well. Remember that it is never too late to learn. There are many good courses available online, and offline. There are many great books to read. Many economists write newspaper and magazine columns and many have web sites you can go to. By doing so you’ll be able to learn at the feet of the masters. See how their minds work, and what currencies they are currently investing in, and you’ll be in a better place when it comes time to make those hard decisions yourself. Also going online and meeting other people in forums and chat rooms who share your interest will give you more insight and knowledge. Like anything else in life, forex trading is a job that you must prepare for. The better educated you are, and the better prepared you are, the more likely you will be to be successful.

?Ride the Wave ??” The Elliott Wave Theory for Forex Markets

One of the best known and least understood theories of technical analysis in forex trading is the Elliot Wave Theory. Developed in the 1920s by Ralph Nelson Elliot as a method of predicting trends in the stock market, the Elliot Wave theory applies fractal mathematics to movements in the market to make predictions based on crowd behavior. In its essence, the Elliot Wave theory states that the market ??” in this case, the forex market ??” moves in a series of 5 swings upward and 3 swings back down, repeated perpetually. But if it were that simple, everyone would be making a killing by catching the wave and riding it until just before it crashes on the shore. Obviously, there’s a lot more to it.

One of the things that makes riding the Elliot Wave so tricky is timing ??” of all the major wave theories, it’s the only one that doesn’t put a time limit on the reactions and rebounds of the market. A single In fact, the theories of fractal mathematics makes it clear that there are multiple waves within waves within waves. Interpreting the data and finding the right curves and crests is a tricky process, which gives rise to the contention that you can put 20 experts on the Elliot Wave theory in one room and they will never reach an agreement on which way a stock ??” or in this case, a currency ??” is headed.

Elliot Wave Basics

? Every action is followed by a reaction.

It’s a standard rule of physics that applies to the crowd behavior on which the Elliot Wave theory is based. If prices drop, people will buy. When people buy, the demand increases and supply decreases driving prices back up. Nearly every system that uses trend analysis to predict the movements of the currency market is based on determining when those actions will cause reactions that make a trade profitable.

? There are five waves in the direction of the main trend followed by three corrective waves (a “5-3″ move).

The Elliot Wave theory is that market activity can be predicted as a series of five waves that move in one direction (the trend) followed by three ‘corrective’ waves that move the market back toward its starting point.

? A 5-3 move completes a cycle.

And here’s where the theory begins to get truly complex. Like the mirror reflecting a mirror that reflects a mirror that reflects a mirror, the each 5-3 wave is not only complete in itself, it is a superset of a smaller series of waves, and a subset of a larger set of 5-3 waves ??” the next principle.

? This 5-3 move then becomes two subdivisions of the next higher 5-3 wave.

In Elliot Wave notation, the 5 waves that fit the trend are labeled 1, 2, 3, 4 and 5 (impulses). The three correcting waves are called a, b and c (corrections). Each of these waves is made up of a 5-3 series of waves, and each of those is made up of a 5-3 series of waves. The 5-3 cycle that you’re studying is an impulse and correction in the next ascending 5-3 series.

? The underlying 5-3 pattern remains constant, though the time span of each may vary.

A 5-3 wave may take decades to complete ??” or it may be over in minutes. Traders who are successful in using the Elliot Wavy theory to trade in the currency market say that the trick is timing trades to coincide with the beginning and end of impulse 3 to minimize your risk and maximize your profit.

Because the timing of each sequence of waves varies so much, using the Elliot Wave theory is very much a matter of interpretation. Identifying the best time to enter and leave a trade is dependent on being able to see and follow the pattern of larger and smaller waves, and to know when to trade and when to get out based on the patterns you identify.

The key is in interpreting the pattern correctly ??” in finding the right starting point. Once you learn to see the wave patterns and identify them correctly, say those who are experts, you’ll see how they apply in every facet of forex trading, and will be able to use those patterns to trigger your decisions whether you’re day trading or in it for the long haul.