Much time and effort for technical analysis is taken up with studying charts. Practitioners believe that the factors that influence prices, such as the effects of supply and demand, established trends, and other elements are clearly visible in any chart. Most price charts plot price movements over time or by volume of trades. Charts are often formatted via a trend line so that price direction can be easily read. Bar charts or candlestick charts are also used to display the high, low, open and close prices for each period.
Technical analysis can be particularly helpful in assisting an investor with entering, exiting, and managing the risk of positions. A number of analytical tools are available as described below.
Trend following analyzes historical data in order to establish whether a sustained movement in a particular direction is occurring. This normally involves looking at different periods, such as 2-day and 7-day moving averages. If the moving average for the shorter period crosses significantly above or below that for the longer period, then an upward or downward trend has developed.
Tracking momentum is sometimes known as Moving Average Convergence Divergence (MACD) and determines whether an asset’s momentum is rising or falling. It is used to track the daily changes in short-term and long-term averages. If the short-term averages are larger, momentum is increasing, while larger long-term averages suggest a decreasing momentum. Slowing momentum indicates the rate of change will decrease and may eventually reverse.
Mean reversion involves identifying an asset’s mean and then determining if the asset price is settling back to that point. It is rather like testing a rubber band to see how far it will stretch before it snaps back.
Analysts employ technical indicators such as Bollinger Bands to measure mean reversion. Bollinger Bands employ various statistical factors, such as supply management, in order to generate a set of bands to contain the price action. Bollinger bands allow any trader to instantly view price on a chart relative to its volatility mean over a period of time.
Volatility is the rate at which the price of a currency pair moves up and down in the market. When high volatility can be seen, the upper and lower Bollinger bands widen and when the price fluctuations decrease, the bands contract. The price usually bounces off the range whenever it touches the upper or lower band.
A second group of technical indicators that are used to measure means reversion are Relative Strength and Stochastic indicators. Both of these technical indicators measure how fast a market has moved in the short term, relative to movements over a longer period. Stochastic indicators, in particular, are based on the principal that in an up trending market, stocks tend to close near their highs and in a downward market stocks tend to close near their lows. These indicators create an index that is used by traders to determine if a market is overbought or oversold.
In general, technical indicators are successful because of their popularity among traders, which is based on the reasoning that ‘volume generates movement.’ The logic follows that the more investors who are trading in a certain direction, then the more that direction is set to continue. By utilizing these indicators, a trader is essentially trading in the same direction as many others. This insight can be useful when trading short term.
In this type of analysis, the trader is looking at specific patterns within the price action. This will help him determine whether any recognizable patterns reveal a predisposition for him to forecast a specific price move. Any example of this type of pattern is a head and shoulders pattern in which two shoulders and a head can clearly be seen. In general, the market will fall after forming the second shoulder.
There are a number different types of technical analysis that traders can use such as single-line crossover, center-line crossover and price action. When trading with charts it is important for the trader to know how to use such indicators as Moving-Average, MACD, Support + Resistance.
In order to engage in technical analysys you will need access to more sophosticated charting tools than most brokers provide. Don’t worry there are many websites that provide this level of charting free of charge. You can also use MetaTrader 4 (MT4) the industry standard FOREX trading platform.
Below we have provided you with trading techniques and also information on how you can use the indicator’s mentioned above to help you become a more successful trader.
Moving average convergence/divergence is a technical analysis indicator created by Gerald Appel in the late 1970s. It is used to spot changes in the strength, direction, momentum, and duration of a trend in a stock’s price. The MACD “oscillator” or “indicator” is a collection of three signals (or computed data-series), calculated from historical price data, most often the closing price.
These three signal lines are: the MACD line, the signal line (or average line), and the difference (or divergence). The term “MACD” may be used to refer to the indicator as a whole, or specifically to the MACD line itself. The first line, called the “MACD line”, equals the difference between a “fast” (short period) exponential moving average (EMA), and a “slow” (longer period) EMA. The MACD line is charted over time, along with an EMA of the MACD line, termed the “signal line” or “average line”. The difference (or divergence) between the MACD line and the signal line is shown as a bar graph or histogram time series. A fast EMA responds more quickly than a slow EMA to recent changes in a stock’s price. By comparing EMAs of different periods, the MACD line can indicate changes in the trend of a stock. By comparing that difference to an average, an analyst can detect subtle shifts in the stock’s trend.
As the MACD is based on moving averages, it is inherently a lagging indicator. However, in this regard the MACD does not lag as much as a basic moving average crossing indicator, since the signal cross can be anticipated by noting the convergence far in advance of the actual crossing. As a metric of price trends, the MACD is less useful for stocks that are not trending (trading in a range) or are trading with erratic price action.
Support and Resistance
Support and resistance are among the most widely known and widely used Forex trading concepts and strategies. These are the levels in the markets, which price has not been able to break outside of. Support levels are the areas which price cannot seem to break below. If a break does happen, it is only temporary and the price soon returns above the level. Resistance levels are the areas, which prevent the price from rising further.
These levels act like a ceiling and appear to force price back down when it tries to break above the level. It is essential to bear in mind that support and resistance levels are not exact numbers, but offer traders a clear indication based on past performance that when price reaches either a support or resistance level it is likely to bounce back. Support and resistance is a concept in technical analysis that the movement of the price of a security will tend to stop and reverse at certain predetermined price levels. A support level is a price level where the price tends to find support as it is going down. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely to continue dropping until it finds another support level.
Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support. Support does not always hold and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.
Signal Line Crossover
Signal line crossovers are the most common MACD signals, which traders use when trading. The signal line that most people use is a 9 day EMA. As a moving average of the indicator, it trails the MACD and makes it easier to spot MACD turns. When using single line crossover you will have two different types of movements. One will be a bullish crossover which is when the MACD turns up and crosses over the signal line. The other type of movement is a bearish crossover which happens when the MACD crosses below the signal line. Two things that most traders must keep in mind when using this strategy is that due diligence is required and it is best to trade this strategy when the asset is volatile. Signal line crossovers a or negative extremes should be viewed with caution. Even though the MACD does not have upper and lower limits, chartists can estimate historical extremes with a simple visual assessment. It takes a strong move in the underlying security to push momentum to an extreme. We will usually see this type of extreme movement when major economic announcements are made.
The movement of an asset’s price. Price action is encompassed in technical and chart pattern analysis, which attempt to find order in the sometimes seemingly random movement of price. Swings (high and low), tests of resistance and consolidation are some examples of price action. The candlestick and price bar are important tools for analyzing price action, since they help traders visualize price movement. Candlestick patterns such as the Harami, engulfing pattern and cross are all examples of visually interpreted price action.