Everything You Need to Know About Forex Technical Analysis
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Everything You Need to Know About Forex Technical Analysis
What makes a true Forex market professional? For starters, it’s some very specific characteristic values such as patience and logic. Then there is the knowledge of currency exchange market and a certain set of trading skills. But above all, the main quality of a professional Forex trader is the ability to systemize the data from the market and use it to plan successful trades ahead. Most Forex newbies quickly get discouraged by the fact that there is so much to learn in order to get any good results. That is a major mistake because the best part about acquiring knowledge is that it can always be broken down into easy to follow stages. To set a clear example of how simple it is to understand complex matters when they are presented correctly, we have gathered everything you need to know about Forex technical analysis. In here you will find out:
What is Forex technical analysis and how does it work
What is the difference between fundamental and technical analysis in Forex trading
Forex technical analysis basics
Best technical analysis tools in Forex trading
Types of Forex technical analysis charts
Advantages and disadvantages of automated technical analysis
How to practice technical analysis in Forex for free
So, buckle up and let’s dive in to the complicated but extremely systemized and approachable aspect of successful Forex trading - technical analysis.
What is technical analysis in Forex
The technical analysis in Forex market is the way to organize the market data in order to detect trends and patterns. In simple words it is the way to read Forex charts in order to understand what is happening at the market. Traders use technical analysis to not only study the market but also to plan their future trades based on what they have learnt. There are numerous strategies and approaches when it comes to identifying patterns in Forex charts. The most popular ones are:
Finding the “textbook” chart patterns. There is a high number of existing patterns that are bound to appear at the graph from time to time due to market’s recurring nature. To identify such patterns the analyst can draw horizontal lines on the chart or use a Fibonacci sequence to systemize the data provided on the graph. By establishing such patterns we can have a straightforward image of how the market is behaving at the moment and what are the strong and weak parts of the majority of traders.
The trading indicators are used to provide signals on certain market conditions such as high activity that lead to an asset being oversold or on the contrary over purchased.
Candlestick chart patterns. We will talk about candlestick charts in more detail further on, as of know it is important to mention that this type of technical analysis helps the trader to get more precise information on how other market participants are tending to act at the chosen point of time and what action should be taken next.
Disregarding of which pattern identifying solution you prefer, the main idea behind best technical analysis in Forex is to get the full picture of the market and build an action plan based on what you know. Depending on what information you have gathered through technical analysis you might get a solid idea on when it is best to open a new trade and when to close it. Sometimes you might even come to a conclusion that it would be smart not to trade at all. And the more you go into mastering Forex technical analysis strategies and techniques the more automatic your decision making process is going to be. Now, before we get technical it is important we briefly discuss the other type of Forex market analysis that can be used separately or in combination with the technical one. Let’s talk about Forex fundamental analysis.
Fundamental vs technical analysis in Forex
We already know that technical analysis is a purely mathematical study of price behaviors through the market chart. Now, the fundamental analysis is something that takes place primarily outside of the market itself. Forex fundamental analysis focuses on understanding such factors as political, economical and social conditions in the world. So many different factors have to be accounted for in fundamental analysis, including: employment rate in major economical governments, the inflation situation, elections, migration, summits and many others. Judging by this it is sort of needless to say that many traders tend to stick to technical analysis, as it is easier to keep under control and perform on your own without having deep knowledge of the world’s economy. But it is also fair to say that sometimes the best strategy is to combine technical analysis with fundamental one to have a clear view of the market. To better understand how each analysis benefits traders, below there are some advantages and disadvantages of both technical and fundamental analytical approaches.
Advantages of Forex technical analysis
Does not require any prior general knowledge. All you need to keep in mind when you use technical analysis is how to properly read the result data.
You can easily get all the necessary tools for free with the trading platform.
Due to its extreme technicality this type of analysis can guarantee a very foolproof action plan in most situations. Of course, this applies when the analysis is performed and read correctly.
There are many tools and approaches with various levels of complexity when it comes to Forex technical analysis. This means that depending on your personal trading style you can select the type of technical analysis that fits you best.
You can learn Forex technical analysis basics in a short period of time once you pay attention and make sure you understand everything you study.
Disadvantages of Forex technical analysis
Because of its popularity the technical analysis can become a cause for a separate trend or an entire sudden market change. This happens when a large number of traders use the same analytical technique and come to the same solution for their trades. That way an assumption, no matter how right or wrong, can become a trend on its own and affect the price value outside of the logical course of action.
In some scenarios, technical analysis report might appear useless without some fundamental analysis. And while it is a rare case in currency trading, this can still cause some confusion in the process.
There is almost no room for a mistake, so in order to achieve proper analysis results, the trader needs to follow the required steps precisely and pay very close attention to detail. Because in this case you snooze - you lose.
Advantages of Forex fundamental analysis
Fundamental analysis gives tarders an opportunity to understand not only what trends are taking place but also why exactly are they happening. This can be defined as a next level trading due to its high complexity.
For the traders who come from certain professional fields fundamental analysis can be easier than for others. For example, anyone with some experience in investment banking or economical analytics can have a better grasp on fundamental analysis.
In the scenario when fundamental analysis report is backed up by some solid technical analysis it can almost guarantee a successful long term outcome.
Disadvantages of Forex fundamental analysis
First and most importantly, fundamental analysis can get very confusing. There are a lot of supporting tools that can be subjective and ultimately converse with each other. This can be avoided but it is also fair to say that it can be hard to do.
It is really time consuming. Both mastering the tactics and following them afterwards can take up a lot of your time. This is easily explained by the amount of factors that contribute to fundamental analysis. Once you find all the right sources, you then need to dig through to find information specific to your chosen currency pairs, and then you have to correctly interpret it to implement in trading correctly.
The fundamental analysis can suggest actions that seem correct but might not necessarily work. Because although Forex can be structured, it can also be highly unpredictable at times.
From all of the above we can draw a simple conclusion that technical analysis does not require as much previous knowledge and experience and can serve effectively. To implement the technical analysis strategies correctly it is important to understand the theory behind this kind of analyis. Next we are going to disucss what basic factors make up the technical analyis.
Forex technical analyis basics
Any Forex technical analysis tutorial will have the same explanation for the logic behind technical analysis. The analyzed information comes from the chart and the chart is nothing more than an expression of a price value movement. So why does the actual price chart play such an important role? There are three major aspects that contribute to that:
The entire concept of technical analysis is based on the Dow theory. Charles Dow was a journalist at the end of the 19th century and a founder of The Wall Street Journal. His theory has many layers but in a nutshell its main idea is that the price value (or the stock value) is everything you need to know about the market as it contains all the necessary information. In other words, this means that no matter what factor caused the price changed, the final value reflected on the chart is what we need to look at. By focusing on the value itself the trader can freely disregard all of the outside conditions that affected the shift, and therefore get more precise results.
Another side of the Dow theory that reflects in the way we look at modern technical analysis is the statement that price moves in trends. More often than not the value of any currency pair will continue moving in the same direction before making a reversal which will resemble a vague U-turn on the chart. Very logically, by detecting the direction of this movement we can identify the trend and use it in trading accordingly. The more time you spend working with charts the better understanding you will have about trends and the ways to utilize them in your trades.
One more crucial principle of technical analysis is the fact that the market tends to run in patterns and loops. Which means that analyzing the previous data on a specific currency can give you an idea of how this pair behaves and what can be considered a trick of mastering it. Additionally, studying of past data can assist the trader with testing a trading strategy they are looking to adopt. Because even if you think you came up with something unique and revolutionary, the chances are always that someone came up with it before.
As you can see, the technical analysis comes from a place of logic and structure. And as long as you follow through all the stages in the correct order you will achieve the desired outcome in no time. It is time we get a little more technical and talk about specific tools you will need for the Forex charts technical analysis.
Best technical analysis tools in Forex trading
The main tool in any trader’s professional arsenal is without doubt their trading terminal also known as the trading platform. There are a number of trading platforms presented at the market right now, but for the sake of keeping this straight to the point we will focus on the cream of the crop - Metatrader 4 trading platform.
Metatrader 4 or MT4 for short has been the number one choice of many Forex traders for quite some time. This can be explained by the fact that MT4 is both convenient and highly effective when it comes to online currency trading. As for Forex technical analysis, Metatrader 4 comes with built in tools for working with the chart as well as with the option to choose from a long list of addons. Some of the default tools will include a line drawing instrument which can help the trader to highlight the trend or even measure the exact angle of the said trend. While the addons usually come in the form of various indicators which we are going to cover later on.
MT4 has proven itself to be an irreplaceable tool for efficient technical analysis. Metatrader 4 allows its users to take advantage of fully customizable set up, multilingual support, automated trading, live charts and many others. And the great news is: all of its sophisticated features are available to you at no charge whatsoever. Simply click here to download the platform and start your journey to success today. In the next segment we are going to focus our attention on the Forex technical analysis charts and all the specific tools that can assist the trader in reading the graph and getting it to work for their benefit.
Forex technical analysis charts
Before attempting any of Forex technical analysis strategies the trader needs to start by choosing how they want the information to be presented. There are three types of charts to choose from: line chart, candlestick chart and bar chart. Now, it is also important to note that you do not have to stick with just one chart throughout your entire market experience. In fact, it can be wise to cross check between charts and compare the results to work out the most effective Forex trading strategy. Here is some basic information on each type of chart:
Line charts. The line chart can look slightly like a chaotic cardiogram - a single broken line that connects all of the closing price values in the selected time frame. This type of chart is mostly used to determine long term trends because it can lack precision. This is where the supporting tools such as drawing lines instrument come in. By inserting additional lines on the chart, the trader can clearly identify the trend and come up with an action plan. Line charts are mostly favoured by the new traders as they are the easiest to comprehend chart type.
Bar charts. The bar charts can also be referred to as Open, High, Low and Close (OHLC) charts. Each bar looks like a vertical line with short horizontal markings at the top and at the bottom. The marking to the left will be the opening price value and the one to the right - closing value. Based on the location of these markings the analyst will be able to tell what were the highest and the lowest prices of the chosen currency within the specific timeframe. Plus, the color of the bar might differ depending on the relation of the opening price to the closing price. The bar chart can reflect the level of control that buyers and sellers have over the market at the chosen time. This type of charts also serves as the foundation for the candlestick chart.
Candlestick charts. This is the most popular type of charts, that is used in most Forex lessons on technical analysis. The candlesticks track all the way back to the 18th century where they were used by Japanese rice merchants in order to keep a record of their transactions. Each candle looks like a thick vertical box with small vertical markings at the top and bottom. The box represents the body of the candle and can differ in color and size. The color also sometimes reflects in density (the box can be empty or filled with black) and shows the relation of the opening price to closing price. When the closing price is higher than the opening one the candle turns green and is called bullish, and on the opposite when the opening price is higher the candle will show red and referred to as bearish. The top of the bullish candle will show at which price the close occurred while the bottom will reflect the open. And vice versa with the bearish: top for open, bottom for close. The top vertical marking is called a wick or an upper shadow and marks the highest price value, and the bottom marking also known as the shadow represents the lowest one.
Candle charts can be looked at as the most precise and therefore the most commonly used. So next we will focus on identifying patterns on candlestick charts.
Forex candlestick chart patterns
As we have already established the logic behind Forex technical analysis in general and the specifics of candlestick chart in particular, we can go into some detail about a few commonly occurring patterns on the candle chart. One thing to understand before we move on is that one candle can represent different values depending on the time frame you choose. For example on the intraday chart one candle can stand for one hour or even one minute, while on the daily chart a candle will represent one day.
Generally, by the amount of bearish candles versus bullish ones the trader looking at the chart will be able to tell who dominated the market - the buyers or the sellers. By understanding the current situation we can create a picture of what should be happening next, or in other words what is the pattern on the chart. The action plan will include what type of position the tarder should be holding - long or short and what are the best times to enter and exit the market. A fun part about learning various patterns is to go through a bunch of peculiar names like “Falling Window” or “Three White Soldiers”. These names can also serve as a handy trick to remembering all of the majorly recognized patterns.
The patterns can be simple and consist of just one candle. For example, a Dragonfly Doji candle that looks like a capital “T” is formed when both opening and closing price values are at the highest of the day. The long shadow in Dragonfly Doji can signal a bullish trend, while its appearance at the bottom of the bottom of the market can indicate the reversal of the trend.
On the other hand, there are complex patterns that consist of two and more candles that form a distinguishable sequence. For instance, Three Black Crows are three long bearish candles (red or black) with one lower than the prior. This pattern indicates that the closing patterns are approaching or are at their lows. If positioned at the top the Three Black Crows can be read as the top reversal signal. The more you know about both simple and complex patterns teh easier it will be for you to read and understand the candlestick chart. You will soon notice that the entire chart consists of a series of patterns that tend to repeat themselves under specific conditions. Now, all three types of charts provide us with a lot of information that needs additional further structuring. Which brings us to the next brief section: technical analysis indicators.
As mentioned above, trading indicators are add ons to the platform. They are designed to extract specific statistics from bar and candle charts by processing the given data through various formulas. Metatrader 4 offers to choose from over 50 different indicators each with its specific purpose. Don’t worry if it seems overwhelming at first, once you get comfortable with a few specific technical analysis strategies you will know exactly which indicators you need to use. And to get a general understanding of trading indicators we can divide them into four virtual groups:
Trend indicators. This type indicates and measures the strength of trends by averaging the price values. For example, if the price is moving above average value it can be read as a bullish trend. The most popular trend indicators are: Moving Average (MA), Moving Average Convergence Divergence (MACD) and Parabolic Stop and Reverse (Parabolic SAR).
Momentum indicators help to calculate the speed of the price movement by comparing the price values at separate moments of time. In a scenario where there is divergence between the price value and a momentum indicator it can represent the upcoming change in prices. Some of the momentum indicators are: Commodity Channel Index (CCI) and Relative Strength Index (RSI).
Volatility indicators are designed to calculate the rate of price fluctuations, disregarding of its direction. These indicators are used to determine the points at which the market might change direction. For example the Standard Deviation indicator measures the expected risk rates and the possible outcome of certain price movements.
Volume indicators. These indicators measure the strength of any given trend or confirm the trading direction by averaging or smoothing out the raw volume. Very simple: increased volume equals strongest trends. Some of the popular volume indicators are Chaikin Oscillator, Volume Rate of Change and On Balance Volume (OBV).
This may be a lot to take in but as you can see now it’s all very possible. However, even with all the necessary knowledge on Forex technical analysis you might still lack confidence to apply your newly acquired skills in the conditions of a live market. Which brought us to a whole other side of Forex technical analysis - automated trading analysis.
Advantages and disadvantages of automated Forex technical analysis
First, a few words on the entire concept of automated trading. This type of trading is a total opposite from the traditional manual trading as it is performed completely by a specifically designed piece of software. Automated trading software can also be referred to as a trading robot or an expert advisor (EA). Forex robot’s job is to fully replace its user at the market. This means all you have to do is set it up and invest the initial amount to get started. The advisor then does the rest of the tasks including technical analysis, strategy development and testing, damage control and trading itself. Essentially this is a way to become a trader without having to do any of the currency exchange related chores. Sounds good, doesn’t it? But just as anything else connected with something as complicated as currency trading the idea of switching to automated trading comes with its own ups and downs. For the purposes of keeping it to the point, we are going to focus on how the advantages and disadvantages of automated trading software apply to technical analysis in Forex trading.
Advantages of automated Forex technical analysis
First and foremost, using a robot can save up a major amount of time. As mentioned previously, there are a lot of ways to approach technical analysis and sometimes choosing the right fit is tricky. With the EA you do not need to worry about what analysis strategy to implement. Additionally, the automated trading robot is able to process the data much faster than any human trader, which means the trading process will be significantly speeded up.
A good automated robot generally has more Forex knowledge than an average trader. In most cases the expert advisor will combine loads of textbook information about the market with the specific professional advice for any difficult scenario from experienced human traders. Needless to say, in this case, knowledge is definitely power and having such sophisticated tool at your disposal can go a long way.
Plus, any of the top automated trading robots have an artificial intelligence unit which allows them to constantly learn from its own experience and develop the tactics and strategies. This makes it virtually unbeatable compared with simplified automated trading robots from earlier days, that basically worked like calculators. When it comes to technical analysis the robot will constantly look for a way to optimize its own performance and get more precise results.
Disadvantages of automated Forex technical analysis
The robot tends to stick to a set of working strategies when it comes to analysis. And while in some cases it is all you need for effective trading, in some rare cases the technical analysis results have to be combined with fundamental analysis, which robot simply cannot perform.
The disadvantage that only applies to some robots is that you won’t really have an idea of how your EA got to the solution it ended up with. However, on the contrary - the good Forex expert advisor will give its users a chance to learn from the process and go through the decision making process report.
In case you do not want to go fully automatic but still find the analysis procedure hard to do on a daily basis, there are some options for semi automatic technical analysis. This happens when a trader chooses to use a technical analysis app or website with technical analysis service. Usually they work partially as trading robots: gather data, organize it and analyze it. What you are then presented with a ready to use report. This can definitely save some time and assists the new traders who do not have much experience in doing their own analysis. But on the other hand the algorithms within these services are usually very simplified to ensure steady performance. So you should not count on an app if you are looking for a full multi layer overview, but you can definitely choose to work with one for some general information.
And in the scenario when you do not like the idea of trusting your technical analysis to a software, you can always do it on your own. Even if you lack experience or confidence, there are ways to practice your analytical skills before entering an actual market. One of such ways is opening a free Forex demo account.
How to practice technical analysis in Forex for free
You might have already heard about demo accounts in Forex. In case you did not they are exact copies of real life trading account with just one difference - the trading is entirely simulated. Meaning, that the setup of the trading platform and even live feed of the price values will remain the same but all the funds you use in trading will not be equivalent to virtual money. So why spend time in demo if you will not make an actual profit? Several reasons actually:
A Forex demo account is a space to apply all of the knowledge you gathered through studying in a safe risk free environment. Some people simply can’t learn until they try and this is the place to to it when it comes to currency trading.
Demo account offers all the same tools and features as the actual one, so you will get comfortable with the terminal prior to starting to trade. This will save you some of that precious time when you move on to the live trading account.
You can experiment as much as you want for as long as you need to. Remember we mentioned that it can take up some time and effort to choose the right technical analysis approach? Well, why not try out as many of them as possible to see what works for you.
You cannot possibly go wrong when you are trading in demo. Since there are no actual money involved, you are free to make mistakes and experiment with your strategy. Even if you end up with a setback it will eventually become a priceless experience that will pay off in the future.
Last but not least, opening a demo account is absolutely free, so there are no reasons not to do it. This creates an amazing opportunity to both practice your newly obtained analysis skills and check if manual analysis is something you can manage on your own.
To open a free Forex demo account all you have to do is go through a few easy to follow steps. As you get your login credentials consider downloading a Metatrader 4 PDF manual to speed up the process of familiarizing yourself with the interface. After that it is time to get creative and try everything you have learned about without risking any of your personal money. In just a matter of couple weeks you should gain enough confidence to start trading on the real market and become a successful Forex trader in no time.
Forex technical analysis: all you need to know
As you have probably figured out from everything above, attention your own technical analysis is very possible. What’s more, you can even have some fun with it once you get yourself in the right state of mind. Just keep in mind that when it comes to Forex you should never stop learning and practicing new skills. Professionalism and high income come with experience, so concentrate on the big picture and do not get discouraged by any setbacks. After all, when you choose to trade with a respected broker and have access to all the necessary tools, success is only a matter of time.