Technical Analysis
Technical analysis is based on three essential principles
Market action discounts everything
This means that actual price is the reflection of everything that is known to the market that could affect it.
Some of these factors are( inflation , interest rate etc)supply and demand, political factors and market sentiments. However the pure technical analysis is only concerned with price movement, not with the reasons for any changes.
Price move in trends
Technical analysis is used to identify the patterns of market behavior that has long been recognized as significant.
For any given pattern there is a high probability that they will produce the expected results.
There are also recognized patterns that repeat themselves on a consistent basis.
History repeat itself
Forex chart patterns has been recognized and categorized over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little over time.
Since patterns have worked well in the past, it is assumed that those patterns would work well in the future.
Trend Lines
Trend Line: a sloping line of support and resistance
Uptrend Line: straight line drawn upward to the right along successive reactions low.
Down Trend Line: straight line drawn downwards to the right along daily successive picks.
Two points are needed to draw the trend line, and the third point to make it valid trend line. Trend line is used in many ways by traders. One way is that when price returns to an existing principle trend line' it may be opportunity to open new position in the direction of the trend in the belief that the trend line will hold and the trend will continue further. A second way is when price action breaks the principle trend line of the existing trend, it is evidence that the trend may be going to fall and the trader may consider in the opposite direction of the existing trend, or existing position in the direction of the trend.
Remember the Trend is simply the overall direction of price movement; up, down of Flat. Below is an illustration of a trend line, comprising of a short and intermediate trend and then the overall long term trend as well; so you can see how trend lines can be broken down further.
TECHNICAL ANALYSIS CATEGORIES/APPROACHES
1. Price Indications (oscillators e.g. RSI)
2. Number theory (Fibonacci numbers, Gann Numbers)
3. Waves (Elliott's wave theory)
4. Gaps (High –low, open – close)
5. Gaps (High –low, open – close)
We will look into trend lines and how they can be used to maximize the information available to you through your superior charting tools on Septafx's MT5 platform. You can learn more about technical analysis by attending one of our FREE weekly webinars.
Types of TREND:
There are Three Types of Trend:
UP TREND
DOWN TREND
SIDEWAYS TREND
TREND ANALYSIS AND TIMING
Markets don't move straight up and down. The direction of any market at any time is either Bullish (Up), Bearish (Down) or Neutral (Sideways). Within those trends, markets have countertrend (backing & filling) movements. In a general sense "Markets move in waves", and in order to make money, a trader must catch the wave at the right time.
DRAWING TRENDLINES
The basic trend line is one of the simplest technical tools employed by the trader, and is also one of the most valuable in any type of technical trading. For an uptrend line to be drawn there must be at least two low points in the graph where the 2nd low point is higher than the first. A price low is the lowest price reached during a counter trend move.
Drawing Trend Lines – Below are some examples of annotated charts with trend lines drawn to help guide you:
Channels
When price trend between two parallel trend lines they form a channel. When prices hit the bottom trend line this may representative of a buying area and when prices hit the upper trend line this may be representative of selling.
Support
Price supports are price areas where traders find that it is difficult for market prices to penetrate lower. This will happen for example if buying interest in the dollar is strong enough to overcome selling interest in the dollar keeping prices at a sustained level. In the chart below you can see the support level in RED. Clearly the price has fallen to this level at least 3 times and failed to go below; hence this is a support level. Eventually this support level gives way but not after holding for a while; giving trader’s valuable information and time to take a view and place their trades.
Resistance
Resistance is the opposite of support and represents a price level where selling interest overcomes Buying interest and advancing prices are turning back. In the example below, a resistance line has been drawn as well as the support line below this. Many times these lines will appear in pairs. This will create a tradable range for a short period of time. During this time the price will move in between the resistance and resistance support levels; until one of these levels is overcome. Then the new trend, along with support and resistance must be determined.
RETRACEMENTS -50% Retracements
Retracement is when a prices resume their original trend for a short time (hence the name) before returning to the current trend. Retracements can be confusing sometimes and mistaken for a new trend but can represent a very short term opportunity for very short term traders such as scalpers or snipers. Below is a graphical representation of a 50% retracement with annotations to help illustrate this:
Line Chart
Point and figure Graph
Bar Chart
Candle Stick
Line Chart
the simplest form based upon the closing trades forming a homogeneous line. This chart does not show what happened during the time unit selected by the viewer, only closing rates for such time intervals. The line chart is a simple tool for setting up for support and resistance levels.
Point and figure Graph
chart based on price without time. Unlike most other investment charts, points and figure charts do not present a linear representation of time; instead, they show trends in price.
Bar Chart
This chart shows three rates for each time unit selected: the high the low and the closing. This chart provides clearly visible information about trading price range during the trading period; so are popular with many short term traders. Below are examples of a EURUSD bar chart; and a breakdown of one bar below to show what information it contains clearly.
Candle Stick
This type of chart represents prices at their opening, high, low and closing prices. Like a bar chart this type of chart contains several key pieces of information and in this case it is represented not as a bar but in the form of candles, for each time frame unit selected. The empty (transparent) candles show an increase, while the dark one shows a decrease. The length of the candle shows the range between opening and closing, while the whole candle shows the whole range of trading prices for the selected unit item.
Trading the breakout
The principle behind trading the breakout is to enter a trade when the price 'breaks out' of a tight range, because often it tends to keep moving in the same direction. We use our Bollinger Bands on our charts to spot this trading opportunity.
In the above example, EUR/USD 5 min chart, notice how the Bollinger Bands tighten and squeeze together. When this happens you know that there is a Breakout coming. As soon as the exchange rate line (brown), breaks out of the outside Bollinger Bands, it signals your entry buy/sell. In this case if you bought EUR/USD at 1.1815 and Closed your position at 1.1840, you could have made a fast 25 pip profit. Notice the confirming indicators: The exchange rate line (brown) is above the EMA 10 (red), the middle BB line (green) and the EMA 50 blue. The Parabolic SAR dots are on the bottom. The MACD Histogram is above 0 signaling upward momentum. The RSI is above 50 signaling upward momentum, and the Slow Stochastic blue line is above the red line signaling bullish momentum.
Trading the trend
Trading the trend is just like trading the breakout, except in less volatile market conditions. Start with going to the 15 minute chart of the currency pair of your choice and ask yourself this question: 'Is the exchange rate line (brown) above or below the EMA 50 (blue)? If the price line is currently below the EMA 50, and the EMA 10 and BB 20 are also below the EMA 50, then you will be looking at Selling opportunities in the trading session. If the price line is currently above the EMA 50, and the EMA 10 and BB 20 are above the EMA 50, then you will be looking at buying opportunities in the trading session. Often, when you are 'trading the trend', you will notice that the price line will bounce off the EMA 10 or the middle BB line or the EMA 50. These lines sometimes act as supports and resistances in a trading session. Therefore you can look to sell shorts when the price line bounces down off the EMA 10, BB 20 or EMA 50, or buy longs when the price line bounces up off the EMA 10 BB 20 or EMA 50. When you trade the trend, it is important to trade with the Parabolic SAR, MACD, RSI and Slow Stochastic all signaling together
The above example is a 5 minute EUR/USD chart. The first thing to look for is the EMA 50 blue line. Notice that it has been above the price line and the EMA 10 and BB 20. You will now be looking to SELL. Notice how the price line bounced down off of the EMA 10 and BB 20 right before I circled the chart.
Now look at your other indicators:
The MACD Histogram turned down below zero, RSI turned down below 50 and Slow Stochastic blue line turned down under the red line. This would have been a good signal to Sell Short—you could have profited at least 20 pips on this trade.
Trading tops and bottoms
Trading tops and bottoms can be more risky that the other two strategies because you are trading against the trend anticipating the market is overbought/oversold and might turn in the other direction. It is best to use the 10 or 15 minute charts for this method. It is more risky using the 5 min charts, but you still can apply the same techniques.
Here is an example of a EUR/USD 15min chart, bottom buy. Notice how the MACD histogram is starting to rise and the RSI is turning up from being oversold and the slow stochastic blue line crossed the red line and is turning up from oversold.
Hedging, using it to your advantage:
Hedging can be a useful tool to the Forex trader. When you have an open position, for example, you are long on a USD/JPY trade and you want to hedge your position in order to protect your losses if the market moves the other way. In order to hedge this position you would need to open a position in the same instrument going the opposite way, (a USD/JPY short). You will now neither gain nor lose any equity in your account because the gains and the losses will cancel each other out and thus you are protected from any losses, but you will not make any profits either until you close one of the two positions (because you have one position in USD/JPY going long and one identical position short, hence negating any gains or losses from one another) and take a definitive decision on the market's direction, but hedging has bought you time to do just this.
Hedging can also be useful if the trade is in your favor
You may also hedge a winning trade to protect your gains, if you don't want to completely close your position. When you do this you won't gain or lose any more money with that position. The advantage to this would give you the opportunity to keep trading those positions in the future and give you a break. You can always close both positions. If you hedge a winning position you can follow the above steps 1-4 to keep trading your position the next trading day. Please note that hedging can get complicated. Try to keep it as simple as possible and try not to have a web of hedged and un-hedged positions open at the same time; as it becomes exponentially more difficult to keep track of, and what positions to let go etc. Hedging is also optional and you don't need to learn how to use this tool if you choose not to. You can be a successful trader by simply using stop and limit orders.
Hedging can help stem the bleeding
Hedging a losing trade won't solve your problems, but it will
Some traders will hedge losing trades instead of stopping out there position, because they have a chance to win back the losses of the original bad trade. For example: You are looking to 'Trade the Trend' so you go long on the EUR/USD. The indicators signaled BUY so you opened up a long position. In case the market goes against you; you choose to hedge instead of using a stop loss. In this case your fears are confirmed and the market moves against you. Now because you hedged your trade; you have a losing position and a winning position going in the opposite directions
When your position is hedged, you are safe and you won't lose any more money in your account. There are various options form here:
- Wait until another chart set up occurs and proceed to step 4. or go to step 2
- Wait till the next trading day or session and use your analysis tools to identify another trend
- Instead of opening up another position, simply get rid of the bad position that was hedged. So if the indicators the next day signaled long in the EUR/USD, like in the above example, then you would get rid of the short, losing hedge and hope that the price will rise enough to erase the previous day's losses to make a profit.
- If your position moves against you again you can hedge that position again and repeat steps 1-3.
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