Trading the forex market is a lucrative business many people are venturing into. While some are making it big time, others are still struggling, hoping things will get better with time. Things can change with time, for better worse. This depends on what is done differently. There are secrets to everything which indicates those who are making it know something others are ignorant of.
Successful forex trading business is hinged on consistent successful predictions of the market and buying and selling specific currencies accordingly. Knowing when to buy or sell an asset is a skill to learn. Some traders rightly predict the market but are fond of buying and selling their assets at the wrong time.
Predicting the market correctly and profiting from it consistently is made possible by proper market analysis. All the skills needed to make one consistently profitable falls under trading strategy. This article is intended to unveil the power of one of the kinds of analysis popularly called technical analysis ( TA), and how it can be incorporated into your trading strategy for success.
Understanding Technical Analysis
Technical analysis is a term that describes an analysis of the financial market that focuses on trends in prices and trading volume. With this method, traders can identify potential profit opportunities and notice signs of danger.
It is also defined as a trading method used for evaluating investments and identifying trading opportunities using statistical trends obtained from price movements and volume.
Those who make use of this method are called Chartists. Chartists do study charts and other data whilst paying attention to recent price movements, points of interests (high volume areas), support and resistance levels, and technical indicators such as Moving Averages, Relative Strength Index, Bollinger Bands, etc. for price forecasting. Being able to adequately predict the market provides traders with the relevant information necessary for making profitable decisions.
Fundamental Analysis vs Technical Analysis
Among the different kinds of analysis, the two elementary and widely used are technical and fundamental analysis. While technical analysis deals with the analysis of previous data to predict the market, fundamental analysis deals with the analysis of economic data such as inflation reports, consumer price index, employment data, government policies, wars, rumors of wars, news about some relevant companies that affect the currency of countries. While fundamental analysis is useful in most financial markets, technical analysis seems more common among traders.
Technical analysis involves forecasting the financial market using various candlestick chart patterns and technical indicators. Fundamental analysis on the other hand involves the use of economic data, news, and information from the central banks of various economies to inform future price movements.
How Technical Analysis Works.
Technical Analysis Charts
There are about three (3) charts used for technical analysis. They are; line charts, bar charts, and candlestick charts. Every chartist usually decides on the specific type of charts to use for their technical analysis.
Line charts.
This type of chart links the closing price depending on the timeframe under review. For instance, the monthly chart links the various closing prices of each month forming a mapped chart. Traders use this especially to identify long-term trends in the market.
The Bar Charts
The Bar charts are also called the OHLC (Open, High, Low, Close) bar chart. It displays a single vertical bar as a representation of the period under review. When a trader is viewing the hourly chart, every vertical bar represents price movements within an hour. The bar chart is preferred to the line chart by most traders because it demonstrates the open, high, low, and close price values of each timeframe.
Candlestick Charts
The candlestick is the most used among the various charts among chartists. They were pioneered by Japanese rice traders somewhere in the 18th century. The individual candles also show the open, high, low, and close values of each period under consideration. They display a box between the open and closed price values, referred to as the ‘body’ of the candle. The candlesticks are usually colored. The red candles typically represent bear candles whilst the green candles represent bullish candlesticks.
Technical Analysis Strategies To Consider
The good thing is that there are many technical trading strategies that traders can take advantage of. As nothing is 100% perfect, no individual strategy is completely reliable. They all have their weakness. Traders must put this at the back of their minds and ensure good risk management and money management skills. Below are some of the strategies employed by most forex traders:
Support and Resistance Trading Strategy
The concept of support and resistance in forex trading circles encompasses price levels above and below which prices are assumed not to fall or rise, respectively. By studying previous charts, traders can predict these price levels. They are employed to ascertain where and when to enter and exit trade positions.
Support levels are the lowest price at which a currency pair tends to trade, and resistance levels are the highest price at which a currency pair tends to trade. These support and resistance points can refer to the daily lows and highs, weekly lows and highs, monthly highs and lows, etc. The support and resistant lines are determined by supply and demand laws.
As soon as the support and resistance areas (zones) are confirmed, they serve as potential areas for entering or exiting trades. When the price of an asset reaches a support or resistance point, it will either bounce off it or break it while continuing its original trend until it hits another support or resistance level.
Range Trading Strategy
Range trading (channel trading) is a strategy that identifies and profits from price movements within price ranges. Market ranges are formed when there is no specific direction to the market, hence the market moves within a range of prices. This strategy is therefore useful when the market lacks a specific direction, forming a range. As prices approach the resistant level of the range traders would go bearish and bullish when price approaches the support level of the range. To adequately trade this strategy, it is crucial to know the different kinds of ranges that the market forms. Examples of these ranges include:
- Rectangular Range – this kind of range is formed when the price of an asset or currency pair moves within a bounded range in which the resistance and support levels are parallel to each other, producing a rectangular shape.
- Diagonal Range — the diagonal range is characterized by either descending or ascending through a sloping trend channel. Because breakouts occur at the other end of the channel it is easier for traders to predict breakouts before they occur however, these channels can take several months and even years to form hence it becomes difficult to expect breakouts.
- Continuation Ranges — a range that develops in the middle or within a trend. The advantage is that it occurs more frequently, therefore breakouts can bring more profit to traders who understand how to trade it. Nevertheless, because it occurs within trends, it becomes difficult especially for newbies in the market to easily identify.
- Irregular Ranges — these are ranges that do not follow any particular pattern or form hence becomes difficult to identify the support and resistance areas. But for traders who have mastered how to figure these support and resistant lines, it is a powerful strategy. Traders would need additional tools to enable them to identify support and resistant points, and also identify potential breakouts.
Charts Trading Strategies
The chart trading strategy is based on patterns formed on charts (bar, candlestick, or line charts) that can be analysed and traded. Traders study these charts and based on historical data can spot patterns that were formed in the past and based on the resultant move would also sell or buy. Below are examples of chart patterns:
- Continuation Patterns – These patterns indicate that the price is about to continue its original trend after a period of temporary consolidation. Traders who know these patterns can make a lot of profit by trading them. One example of a continuation pattern is the pennant. Pennants are formed by trend lines moving in two directions, but eventually converge at one point. Whilst one of the trend lines is in a downtrend, the other is in an uptrend. The signal for entering the trade is provided when these two trend lines meet.
- Flags are patterns formed often in smaller time frames that move against the major trend as seen in the higher time frames. They characteristically are formed by two parallel trend lines that are ascending or descending. An ascending flag usually breaks the pattern to continue a prevailing downtrend. A descending flag would break the pattern to continue a prevailing uptrend.
- Wedges are patterns that are made up of two trend lines that typically move in similar directions but the space between them gets narrower as the price continues to move. The upper trend line represents resistance, whilst the downward trend line represents support. There are the rising and falling wedges that are used by traders to enter positions and exit positions depending on the breakout that occur.
- Other chart patterns include head and shoulder patterns, double tops, double bottom, gaps, reversal patterns etc.
In conclusion:
The above strategies are just a few of the technical analysis trading strategies. The other strategies not discussed in this article but are equally important, include volume trading strategies, technical indicators trading strategies, trend trading strategies, etc. Some traders have learned to combine some of these strategies to form one solid strategy, yet they are still far from perfect.
These combined strategies surely have their flaws, only that such flaws are minimal compared with individual technical trading strategies. Most importantly, the one using the strategies is a matter of grave concern. Traders must therefore invest in learning and sharpening their trading psychology to effectively incorporate these technical analysis strategies into their ultimate trading strategies for consistent profit making.
