What is Technical Analysis in Forex Trading

What the charts tell us - technical analysis of currency pairs

Most of the tools available in Technical Analysis (TA) work well in forex trading. Classic chart formations such as trend channels or resistance and support lines can be used as well as advanced techniques for trend recognition, indicators and oscillators as well as candlestick formations.

Currencies are trending

Currencies are one of the most trending asset classes. Since both positive and negative forecasts can easily be converted into long or short positions on the Forex market, the direction of the trend - unlike, for example, with stocks - is irrelevant for the trader. On the other hand, there are also currency pairs that spend most of the time in sideways phases. In particular, currencies from comparable economic areas often move sideways over long periods of time. As soon as one of these two economies develops significantly better or worse than the other, a new trend emerges from the sideways movement. These two conditions (trend and sideways movement) can usually be easily distinguished from one another on the currency market.

Point & Figure and Renko

Due to the trend behavior of foreign currencies, a relatively unknown type of chart is suitable for analyzing the exchange rate: the so-called "Point & Figure Charts" (P&F). This is an alternative display variant to the widely used bar and candlestick charts. Image 1 shows the difference between the chart types.


Would you like to delve deeper into the topic of time-independent charts? Then these articles are sure to help you further:

Renko:

Point & Figures:


The focus of the P&F chart is no longer the price development measured against time, but the development of the price. Times in which only minor price changes take place (i.e. sideways movements) are filtered out of the chart image. Accordingly, the chart has a variably scaled time axis. The so-called “Renko Charts” are a similar representation variant, but one that is easier to understand visually. In both types of chart you can work with trend lines, indicators and formations. When using it, you should always note that the time axis is variable in contrast to "normal" charts. It can therefore happen that the chart does not change over a longer period of time if the price fluctuations were too small or if no major movement has developed. Both point and figure charts and Renko charts can be applied to daily and intraday data.

Image 1: Comparison of Renko (top), Point & Figure (middle) and candlestick charts (bottom) In the Renko chart, each box (brick) represents a movement of the same number of pips in one direction. In the Point & Figure chart, X represents rising prices and O falling prices in a fixed order of magnitude (for example 60 pips). In contrast, the time axis of the candlestick chart is linear.


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Resistance and support

The prices of stocks often show a long-term upward movement - with more or less long corrections. Currencies and fixed income securities, on the other hand, often fluctuate around a value. The euro was already quoted against the dollar in mid-2006 at the same level as it was last in October 2012. Nevertheless, there were good opportunities for traders to benefit from the upward and downward trend in between. These long-term fluctuations mean that there is often resistance and support at the current price level that result from historical movements. Therefore, it is also useful for short-term oriented traders to deal with long-term charts in order to perceive such zones and incorporate them into the analysis. Furthermore, as a trader, you should always keep an eye on the "big picture" regardless of the time window in which you trade. Currencies often move in stable trends over a long period of time. Therefore, especially as a beginner, it is usually better to trade with the trend and not against it.

Multiple time levels

The method of incorporating several time windows into the analysis and the resulting trading decisions is known in technical jargon as multiple time frame analysis. Primarily two approaches can be derived from the concept. First: Before entering into a new position, many traders check the situation in the higher-level time window (for example, small time window: minute chart, higher-level time window: hourly chart). Only when there is no resistance or support at the same level in the hourly chart as in the minute chart and the exchange rate is not moving in an overriding, opposite trend, do you realize the trade. Second, many traders use the approach to get into a long-term trend. The smaller time window often enables better timing. However, after the entry has taken place, the trade is managed in the longer-term chart. However, there is a risk of so-called "overtrading". Instead of concentrating on the long-term perspective, many traders observe the position in the subordinate time window even after entering the market and thus take unnecessary risks. If you consider support and resistance, you should start with the highest available time window and “work down” to the primary, smallest unit in terms of time.

When analyzing trends, both time windows should be in a meaningful relationship. If you scalp with an expectation horizon of a few pips, you usually do not have to take into account the overarching, long-term trend, for example in the daily chart. With scalping, investors take advantage of the smallest price fluctuations. The positions are often closed after just a few ticks. But a look at the 5-minute chart can also provide new information for scalpers. If your own forecast is confirmed in the higher-level time window, there is a lot to suggest that the trade makes sense.

Fibonacci

The Fibonacci concept is very popular because of its ease of use, especially in forex trading. The Fibonacci sequence is a series of numbers that begins as follows: 0, 1, 1, 2, 3, 5.8, 13. The following number is obtained by adding the two predecessors (3 + 5 = 8 ; 5 + 8 = 13 and so on). For traders, the resulting ratio of 61.8 percent (the ratio of a number to its successor) and the equivalent of 38.2 percent (100 percent - 61.8 percent) are of particular interest. These two quotients are used to estimate the likely extent of a corrective movement after a price movement. The resulting Fibonacci levels serve as a resistance or support zone. In addition to estimating corrective movements, the method can also be used to determine course targets. When using Fibonaccis one should make sure that the market does not usually turn exactly to the pipeline. Frequently, only a brief lingering at the level can be observed before the market continues its movement. As soon as a Fibonacci mark has been breached, it is to be regarded as invalid and not to be further included in the analysis. It is recommended to use Fibonaccis in combination with another approach. For example, if a Fibonacci level coincides with a trend line, it often gives a strong signal. The combination with candlesticks or indicators can also work.

Picture 2: The chart shows a "hit" of the Fibonacci ratios. After the initial downward movement in the EUR / JPY stopped, the price covered exactly 38.2 percent of this distance as an upward correction. The Fibonacci point marked the end of the correction. The price then hit new lows.


Read more about Fibonacci:

Fibonacci - much more than just number theory


Pivots

Pivot points were developed by traders on the exchange floor and originally come from futures trading. Today they are increasingly used in forex trading as well. Due to their ease of use, pivots are enjoying growing popularity among both institutional and private traders. Pivot points are calculated support and resistance levels. The calculation is usually carried out using daily data. However, they are used (almost) exclusively in short-term intraday trading. Based on a midpoint, two or three resistances and supports are usually calculated. Over the years, a large number of variations on the classic calculation have developed - among other things, to take opening gaps into account. To calculate the pivot point for the current day and the support and resistance levels based on it, the high, low and closing prices of the previous day are required:

Pivot Point (PP) = (High + Low + Close) / 3

Supports (U): U1 = (2 * PP) - high U2 = PP - high + low U3 = low - 2 * (high - PP)

Resistances (W): W1 = (2 * PP) - low W2 = PP + high - low W3 = 2 * (PP - low + high)

The calculated supports and resistances function like classic support and resistance areas. Observing the pivot points and the support and resistance based on them is especially interesting on uneventful days. The market often fluctuates between the first resistance and the first support. If the market leaves this area in one direction, the trend can be expected to continue over the course of the day. On days when high fluctuations are to be expected due to external influences, such as the publication of economic data, the concept has proven to be less successful in the past.

Picture 3: The chart shows the daily pivot points. The lower three marks are the supports U1 to U3, the upper three are the resistors W1 to W3. The middle marker shows the pivot points.

The chart shows the daily pivot points. The lower three marks are the supports U1 to U3, the upper three are the resistors W1 to W3. The middle marker shows the pivot points.


Read more about pivot points:

Pivot Points - Magic Points: Basics

The combination of pivot points with candlestick patterns


Conclusion

One of the advantages of technical analysis is that it can be used universally. Regardless of whether you trade stocks, futures or foreign exchange - the basic concepts of technical analysis can be used in every market and on every underlying asset. The time level also has little influence on the effectiveness of the approach.

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