(PAGE 51-60)
IV. Chart 51
Scaling of Charts 51
Choosing the Proper Time Period 51
Day or Intraday Trading 51
Swing Trader 52
Position Trader 53
Three Methods of Plotting Charts 53
Bar Charts 54
Line Chart 55
Candlestick Chart 56
Common Candlesticks 57
Candlestick Patterns 57
Doji 57
Bearish Engulfing Pattern 57
Bullish Engulfing Pattern 58
Piercing Line Pattern 58
Dark Cloud Pattern 58
Shooting Star Pattern 59
Morning Star Pattern 59
Even Star Pattern 59
Harami Pattern 60
Hammer Pattern 60
Hanging Man Pattern 60
TECHNICAL ANALYSIS
SECTION Four
(PAGE 61-62)
V. Pattern Interpretation 61
Principle 1 - Patterns take on 61
Significance from their size and depth Principle 2 - Do not wait for Perfect Pattern 61 Principle 3 - Combine Pattern Trading 61 with Other Techniques
Identifying Support and Resistance 61
Drawing Trend Lines 62
(PAGE 62-66)
VI. Technical Indicators 62
Moving Averages (MA) 63
Simple Moving Average 63
Weighted Moving Average 63
Exponentially Smoothed Moving Average 63 Application of Moving Averages in Trading 64 1. Determine entry and exit points 64
2. Determine direction of trend 64
3. Determine strength of trend 64
Most Commonly Used Moving 65
Bollinger Bands 65
Methods of interpreting Bollinger Bands 66
1. Breakouts 66
2. Overbought & Oversold Indicators 66
(PAGE 66-67)
VII. Oscillators 66
Relative Strength Indicator (RSI) 66
Moving Average Convergence 67
and Divergence (MACD)
(PAGE 68)
VIII. Stochastics 68
Application of Stochastics in Trading 68 1) Detect overbought and oversold 68 Conditions
2) Divergence 68
3) Trade Signals 68
Rate of Change (ROC) 68
(PAGE 69-70)
IX. The Basic Theories 69
Fibonacci Retracement 69
Application of Fibonacci 69
Retracement Levels in Trading
Factors to consider when using the 70 Fibonacci Levels:
Elliott Wave Theory 70
(PAGE 72)
X. Tips for Using 72
Technical Analysis
TECHNICAL ANALYSIS
Part I. Technical Analysis vs.
Fundamental Analysis
Technical analysis concentrates on the study of market action while fundamental analysis focuses on the economic forces which cause prices to move.
Both of these approaches attempt to achieve the same goal, that is, to determine the direction prices are likely to move. The only difference between the two is that they approach. the market from different angles. In essence, a fundamentalist studies the cause of market movement, while a technician studies the effect.
On the surface, technicians may appear to ignore the fundamentals that drive market movement. It may seem that they are so absorbed by charts and data tables that they become ignorant of the underlying factors that move the market. However, a technical trader will explain to you that all the fundamentals are already represented in the price. In other words, the charts that depict price movements are actually a visual form that illustrates the fundamentals. All economic data are translated into patterns and trends of market prices that could easily be used for making important trading decisions. Basically, technical traders look at the charts to identify the trends in order to predict future prices.
The bottom line when using any type of analysis, technical or fundamental, is to stick to the basics.
The basics are the methods that work for you and have been proven to work over a long period of time.
After finding a trading system that works best for you, other methods and strategies could be gradually incorporated as tools into your trading toolbox.
Part II. Technical Analysis Overview Technical analysis is the study of historical price action and volume data for the purpose of forecasting future market trends. This type of analysis focuses on the chart formations to analyze major and minor trends. It helps to identify buying/selling opportunities
by assessing the extent of market reversals.
Technical analysis can be used on an intraday 5 minute, 15 minute, hourly, weekly, or monthly basis.
Technical analysis is based on 3 assumptions listed in the table below.
Depending on the level of complexity, technical analysis may involve price charts, volume charts, and many other mathematical representations of market patterns. As you advance in your technical trading skills, technical indicators and mathematical ratios may be added to the charts to form a more comprehensive analysis of the market. Therefore, rather than merely relying on price charts, technicians may also use other tools in aid of forecasting future market values.
Currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends. Over 80% of volume is speculative in nature and as a result, the market frequently overshoots and then corrects itself. A technically trained trader can easily identify new trends and breakouts, which provide multiple opportunities to enter and exit the market.
Two Major Forms of Technical Analysis
Technical analysis can be further divided into two major forms:
Quantitative Analysis: uses various statistical properties to help assess the extent of an overbought/oversold currency.
Chartism: uses lines and figures to identify
recognizable trends and patterns in the formation of currency rates.
trend is an overall directional price movement in a pre-defined time interval. It is estimated that 70% of the time, markets will fluctuate randomly or move between support and resistance levels. The rest of the time, market behavior is characterized by persistent price movements — trends — that break through support and resistance levels.
The concept of trends forms the basis of the technical approach. Basically, the sole purpose of charting the price action of a market is to identify trends in early stages of their development for the purpose of trading in the direction of those trends. In fact, most of the techniques used in this approach are trend-following in nature; their intent is to identify and follow existing trends. Once a trend is defined, a sound strategy can reasonably predict its direction and duration. As a result, profits are accumulated and maximized, while losses are minimized.
Types of Trends
One of the first things you will hear in technical analysis is this saying: “Never go against the trend;
the trend is your friend”. Prices can move in one of three directions, up, down or sideways. Once a trend is established in any of these directions, it usually will continue for some period. Based on the direction of movement, there are three types of trends: 1) Uptrend, 2) Downtrend, and 3) Sideways Trend.
Uptrend
An uptrend is a succession of higher highs and higher lows. It indicates a bull market in which the base currency is appreciating in value. In essence, an uptrend can be considered intact until a previous relative low point is broken. A violation of this condition serves as a warning that the trend may be over. Once an uptrend is confirmed, traders should enter a buying position; in other words, go long on the currency pair.
Downtrend
A downtrend is defined as a succession of lower lows and lower highs. It indicates a bear market in which the base currency is depreciating in value. Generally, a downtrend can be considered intact until a previous relative high is exceeded. Once a downtrend is established, traders should enter a selling position, which is also known as shorting the currency pair.
Sideways Trend
A sideways trend indicates a highly volatile market in which prices are moving within a narrow range. In other words, the value of currencies is not appreciating or depreciating in value.
Classifications of Trends
There are three classifications of trends: primary, intermediate, and short-term.
Rally & Consolidation Phases Currency price movements can usually be put into two main categories, a rally phase and a consolidation phase (also known as congestion).
During the rally phase, buyers of one side of a currency pair have the upper hand over sellers, since it is their enthusiasm that strengthens the currency they have chosen to buy. During the consolidation phase, the enthusiasm of both buyers and sellers of both sides of a currency pair becomes more balanced, as neither one is able to win out over the other. Eventually, one will dominate and another rally phase will commence in either direction.
Obviously, every purchase must be offset by a sale, and visa versa. However, if buyers are enthusiastic, they are more willing to accept a higher price which increases the value of the bought currency. If sellers are pessimistic, they are more likely to only be willing to accept a lower price, which decreases the value of the sold currency. Technical traders can notice these price struggles as buyers and sellers battle.
These battles between buyers and sellers appear in reoccurring patterns or formations that can be seen within their charts. These patterns can also be categorized into two groups, continuation
patterns and trend reversal patterns, which naturally correlate with the two above-described phases.
Continuation Patterns
Continuation patterns reflect a gap or pause in trading that the market needs during sharp trends. Such periods of consolidation are usually quite short and often slope against the original trend. In contrast, breakouts occur in the same direction as the original trend. Let’s review, several common continuation patterns that can enhance your technical analysis.
Although these patterns are normally
considered bar patterns, we can also view them with candlestick charts.
Channel or Rectangle
A channel or rectangle is a pattern in which parallel lines can be drawn through or against price bar or candle highs and lows. Channels can be in several directions: horizontal (also called a “rectangle”), inclining, or declining. This pattern is easy to spot since it can be viewed as a brief sideways trend. If it occurs within an uptrend and breaks out on the upside, it is called a bullish rectangle. If the
congestion occurs with a downtrend and breaks out on the downside, the formation is called a bearish rectangle.
Traders frequently trade on the breakout of the channel or test the breakout by placing a small risk stop order inside or on the other side of the channel.
Upon breakout, the market will most likely move in the direction of the original trend.
When a channel follows a strong rally phase, we refer to this as a flag formation since the rally phase resembles a “flagpole” and the consolidation phase (channel) that follows it resembles a “flag”. A flag pattern is very reliable and often easy to see in the early stages of its formation.
Triangles
A triangle is a pattern in which the slope of price bar or candle highs and lows are converging to a smaller pricing area or point so as to outline the shape of a triangle. Triangles can either be symmetrical, ascending, descending, or
expanding. The ascending triangle is recognized by a flat resistance line and an upward sloping support line. The descending triangle is identified by a flat support line and downward sloping resistance line. The much less common expanding triangle is a mirror image of a symmetrical triangle, but the tip of the triangle, not the base, is next to the original trend. Traders frequently trade on the breakout of a triangle or test the breakout by placing a small risk stop order inside the triangle.
When a triangle follows a strong rally phase, we refer to this as a pennant formation since the rally phase resembles a flagpole and the consolidation phase (triangle) that follows it resembles a pennant flag that tapers to a point.
A wedge is a pattern that is similar to a triangle in appearance because it also has converging trend lines coming together at the tip. However, wedges
are distinguished by a noticeable slant in either direction.
There are several breakout-based approaches to trading wedges. The most common approach is to give a bias to the same direction of the overall trend when the wedge is pointed in the opposite direction of the trend.
Below is an example of a falling wedge in a downtrend:
Trend Reversal Patterns
Like most good things in life, all good trends must come to an end. In Forex, this is not unfavorable since we can simply reverse directions and go the other way. Fortunately, there are several trend reversal patterns that often signal the beginning of a new trend, or, at the very least, a strong counter- trend move. Let’s review three common trend reversal patterns that can enhance your trade system. Again, although these patterns are normally considered bar patterns, we can also view them with candlestick charts.
Head and Shoulders
Head and shoulders is a bar pattern that signals a trend reversal. In an uptrend, the market begins to
slow down and forces of supply and demand are generally achieving equilibrium. Sellers come in at the highs (left shoulder) and push the market down until the bearish force slows down (beginning neckline). Buyers soon return to the market and ultimately push through to new highs (head).
However, the new highs are quickly turned back and the downside is tested again (continuing neckline).
Short-term buying reemerges and the market rallies once more, but fails to take out the previous high (right shoulder). Buying subsides and the market turns back to the downside again. The pattern is complete when the market breaks the neckline. Head and Shoulders can be in an uptrend or inverted in a downtrend.
Below is an example of a head & shoulders pattern in an uptrend:
1-2-3 Tops and Bottoms
1-2-3 tops and bottoms is a bar pattern that signals a trend reversal. In an uptrend, the market hits a new high (#1 top), pulls back to a short-term support level (#2 point), and resumes an upward move to a high that is below the #1 high point (#3 point), whereupon it reverses once again. In a downtrend, the preceding definition is inverted. The pattern is complete when the market breaks the #2 point.
Below is an example of a 1-2-3 top:
Double or Triple Tops and Bottoms Double or Triple Tops and Bottoms is another bar pattern that signals a trend reversal. In an uptrend, prices rally to a new high, pull back for an indefinite time period, rally to the same high price area again whereupon they reverse once again. This rally and pull-back action can occur two, three or more times, forming a double or triple top.
Part IV. Charts
The most basic building blocks of technical analysis are price charts. Charts help traders determine ideal entry and exit points for a trade. They provide a visual representation of the historical price action of
whatever is being studied. Depending on their level of sophistication, charts can help with much more advanced studies of the markets.
Scaling of Charts
Pricing on FX Charts is always displayed on the vertical or “Y” axis, either to the right or left side.
Pricing information is plotted on an arithmetic scale which plots each price variance with the same vertical distance; hence, the distance from 1.1400 EUR/USD to 1.1450 EUR/USD is the same as 1.1500 EUR/USD to 1.1550 EUR/USD.
Choosing the Proper Time Period
A day or intraday trader trades in very short time frames of minutes and hours. So, an FX day trader usually sets up a screen page or pages with a daily, 120, 60, 30, 15, 10, 5, or 1 minute chart.
Below is a sample 5 minute chart for day or intraday trading:
Often, an FX swing trader uses data from previous weeks and months to open positions on Monday or Tuesday with a goal of closing these positions by Thursday or Friday. So, an FX swing trader normally sets up a screen page or pages with weekly, daily, 120, or 60 minute charts.
Below is a sample daily chart for swing or momentum trading:
A position trader opens and holds positions in the market for weeks or even months at a time. When trading with this style, the trader is not as concerned about the daily noise in the market. So, an FX position trader sets up a screen page or pages with monthly, weekly and daily charts.
Below is an example of a weekly chart for position trading:
Three Methods of Plotting Charts With technical analysis gaining wider acceptance, technicians have developed more than one way of physically representing market data on charts.
Most charting methods plot prices on the vertical (Y-axis) and the time period on the horizontal (X- axis). Time frames can be anywhere from one minute all the way to one month. There are three widely used methods of plotting charts; they include bar, line, and candlestick charts.
Bar Chart
This method portrays pricing action using vertical bars. The bar represents the trading range for the stated time period. The bars themselves usually
have at least one horizontal mark. The top of the bar records the highest price and the bottom records the lowest price. A mark, extending to the left, records the opening price and a mark, extending to the right, records the closing. One advantage of bar charts is that they can provide a lot of visual information on a single page.
Line Chart
Usually on a line chart, the openings, highs, and lows are ignored. Only the closing price is plotted. A continuous line, with various peaks and valleys, joins the closing prices. The line chart offers less visual information than other charts; however, it can be more helpful in some respects. For example, since the
highs and lows are ignored, most of the market “noise” (short-term price fluctuations) is eliminated. This makes it much easier to spot trends and reversal patterns.
Candlestick Chart
This method was developed in Japan many centuries ago and basically provides the same information as bar charts. A candlestick or candle consists of a vertical rectangle, and often, a vertical line on top of the candle (wick) and a vertical line below the candle (tail).
These vertical lines on the top and bottom are also referred to as the upper shadow and the lower shadow. The rectangle itself is known as the body, which represents the pricing activity between the opening and closing prices.
If the opening price is higher than the closing price, the opening price is recorded at the top of the body and the closing price at the bottom; the candle is displayed in a solid red body. When the opening price is lower than the close, the opening price is recorded at the bottom of the body and the closing price at the top; the candle is displayed with a solid blue body. The biggest advantage of using candlesticks is that they can make it easier to spot certain price patterns that may not be as apparent in other charts. The disadvantage, of course, is that candlesticks take up a lot more horizontal space, giving a smaller view of market activity.
Common Candlesticks
There are 5 different types of candlesticks that are extremely common in the FX market. These candlesticks are as follows:
“A” shows the high and low with no shadows.
“B” shows when the opening and closing prices are identical.
“C” shows a very small trading range.
“D” shows the opening and closing near the high.
“E” shows the opening and closing near the low.
Candlestick Patterns
The information displayed in candlestick charts is identical to bar charts. Each one contains the opening, high, low, and closing prices. However, it is the way that candles are displayed that makes them unique and gives them different interpretive powers. While they can be used for any time period, candlesticks are used most often with daily price data. The most commonly used time scale for candlestick charts is 5 minutes 1 day. It is important to familiarize yourself with the various candlestick patterns. These patterns possess specific forecasting characteristics that indicate buying/selling opportunities.
The information displayed in candlestick charts is identical to bar charts. Each one contains the opening, high, low, and closing prices. However, it is the way that candles are displayed that makes them unique and gives them different interpretive powers. While they can be used for any time period, candlesticks are used most often with daily price data. The most commonly used time scale for candlestick charts is 5 minutes 1 day. It is important to familiarize yourself with the various candlestick patterns. These patterns possess specific forecasting characteristics that indicate buying/selling opportunities.