Technical analysis is the forecasting of the future price movement based on the analysis of its past behaviour. Technical analysis helps trader find the correct solution: when to open a buy or sell position, and when to close it.
The research of technical analysts is based on the price and on what is happening on the chart. It is believed that all the information is already reflected in the price. The chart displays price path that allows monitoring significant market trends, as well as offer and demand changes. The main task of the trader who wants to learn technical analysis is to understand charts. How to analyze the Forex market we'll talk in this article.
What is trend and how to determine it
Forex prices don't move in the same direction, they constantly fluctuate: jump up and down, creating peaks and valleys. If the price movement direction remains stable for some time, the trend is formed.
- upward – shows rise in prices in a certain period of time. If each next maximum and minimum is higher than the previous – it is uptrend.
- downward – shows fall in prices. If each next minimum and maximum is lower than the previous – it is downtrend.
- flat – when price has no definite direction. Highs and lows are on the same level, it means flat.
To determine the trend direction, technical analyst draws a line through the highs/lows. How to build a trend line? On the "Graphic tools" panel find the "Trendline" object and left-click on the chart. Then, draw a straight line through the main highs/lows not releasing the mouse button.
It should be at least two significant lows/highs on the chart to draw a trendline. The more points are, the stronger trend is.
Support and resistance levels
Any market is based on supply and demand for the asset. Both supply and demand affect the quotes. If the demand is higher than supply, prices rise, and vice versa.
In technical analysis, support and resistance levels demonstrate demand and supply. These levels show the mood of the market. Support level is always below the current market price, as if it supports it and does not allow falling below a certain level. On the support level buyers dominate, and sellers back off. Fall in prices stops near the support level, and prices begin to rise. It is recommended to open long positions and close the short ones.
The resistance level is always above price, as if it restrains its further growth. Once the price approaches to the resistance level, the sellers` activity increases, and demand is weakened. The price can not rise above the resistance level. Here it is necessary to open short positions and close the long ones.
To visualize support and resistance levels, trader draws the horizontal lines at those points where the price reversal is viewed. How to draw support/resistance levels? Find 2 lows (where the price reversed up) and connect them by a horizontal line. Resistance levels are drawn similarly, but the line is drawn through the highs (where the price reversed down).
Forex technical indicators: how do they work
Technical analysis can be performed not only manually but also by means of special indicators. Indicators help traders analyze the market: to determine trends, overbought and oversold zones, trading volume, identify possible reversals etc. The trader calculates nothing, as the indicator is based on a formula. The indicators are divided into two main groups: trend and oscillators.
Trend indicators – are used to identify market trends. Trend indicators are built on the price chart. Moving Average is considered to be the most popular trend indicator.
Moving Average (MA) is a measure of the average price value for a certain timeframe. MA is plotted on the chart and has the form of a curve. The curve changes depending on the trend direction. The main task of the moving average is to define the trend.
How to identify trend using MA? If the price moves below the moving average, there is the downtrend, if above – uptrend. If the price crossed the curve, it indicates a possible trend reversal. The trend strength can be determined by the slope of the moving average. The higher it is, the stronger the trend.
Many indicators are based on the moving average. One of these indicators are Bollinger Bands (BB). Bollinger Bands consist of three lines. The middle line is the moving average, the lower and upper are levels at which the price is considered to be low or high compared to the moving average. Bollinger Bands help determine the level of market volatility. If bands are narrowed, there is low volatility on the market. Sharp price changes are usually followed after the narrowing and bands widen again. The wide range of Bollinger Bands indicates a high volatility and a trend movement.
- upward trend – the price is in the upper channel band (above the moving average). If the price crosses the moving average from the bottom upwards, it is recommended to buy.
- downward trend – the price is in the lower channel band (below the moving average). If the price crosses the moving average from the top downward, it is recommended to sell.
Oscillators are used when there is no definite trend on the market. Oscillators are built in the form of curves in the window under the chart. Stochastic and MACD are the most popular oscillators.
Stochastic Oscillator determines the overbought and oversold levels. The indicator consists of two lines: fast %K and slow %D. The %K line is represented by a continuous line, the % D line by a dashed line.
Indicator values range from 0 to 100 percent. By default, in the MetaTrader 4 there are levels of 80 and 20. When the indicator line is below 20, it means the oversold. Then traders consider purchases. If the line rises above 80, the market is in the overbought zone and it is recommended to consider selling.
MACD (Moving Average Convergence Divergence) stands for convergence/divergence of moving averages. In MetaTrader 4, the MACD indicator is presented as a histogram and signal line, which goes along the histogram. If the MACD histogram is in the negative zone (below zero) and below the signal line, it indicates the development of "bearish" moods, and sends a signal to sell. If the MACD histogram is in the positive zone and above the signal line, there is the uptrend on the market.
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