Technical analyses is about studying charts and graphs of the past and present price action and prediction the futue movement of the market price and take wise investment decision.
Technical analysis and fundamental analysis differ greatly, but both can be useful forecasting Tools for Forex trader. They have the same goal - to predict a price or movement. The technician studies are the effects, While the fundamentalist studies the causes of market movements. Many successful traders combine a mixture of both approaches for superior results. If both Fundamental analysis and Technical analysis point to the same direction, your chances for profitable trading are better.
As there are many ways to categorize the tools available, the description of tools here may sometimes seem repetitive.
This means that the actual price is a reflection of everything that is known to the market that could affect it. Some of these factors are: fundamentals (inflation, interest rates, etc.), supply and demand, political factors and market sentiment. However, the pure technical analyst is only concerned with price movements, not with the reasons for any changes.
Technical analysis is used to identify patterns of market behavior that have long been recognized as significant. For many given patterns there is a high probability that they will produce the expected results. There are also recognized patterns that repeat themselves on a consistent basis.
Forex chart patterns have been recognized and categorized for past 100 years, and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little over time. Since patterns have worked well in the past, it is assumed that they will continue to work well into the future
Forex charts are based on market action involving price. Charts are major tools in Forex trading. There are many kinds of charts, each of which helps to visually analyze market conditions, assess and create forecasts, and identify behavior patterns.
Most charts present the behavior of currency exchange rates over time. Rates (prices) are measured on the vertical axis and time is shown of the horizontal axis.
Charts are used by both technical and fundamental analysts. The technical analyst analyzes the "micro" movements, trying to match the actual occurrence with known patterns. The fundamental analyst tries to find correlation between the trend seen on the chart and "macro" events occurring parallel to that (political and others).
What is an appropriate time scale to use on a chart? It depends on the trader's strategy. The short-range investor would probably select a day chart (units of hours, minutes), where the medium and long-range investor would use the weekly or monthly charts. High resolution charts (e.g. - minutes and seconds) may show "noise", meaning that with fine details in view, it is sometimes harder to see the overall trend.
The simplest form, based upon the closing rates (in each time unit), forming a Homogeneous line. (Such chart, on the 5-minutes scale, will show a line connecting all the actual rates every 5 minutes).
This chart does not show what happened during the time unit selected by the viewer, only closing rates for such time intervals. The line chart is a simple tool for setting support and resistance levels.
charts based on price without time. Unlike most other investment charts, point and figure charts do not present a linear representation of time. Instead, they show trends in price. Increases are represented by a rising stack of Xs, and decreases are represented by a declining stack of Os. This type of chart is used to filter out non-significant price movements, and enables the trader to easily determine critical support and resistance levels. Traders will place orders when the price moves beyond identified support / resistance levels.
This chart shows three rates for each time unit selected: the high, the low, the closing (HLC). There are also bar charts including four rates (OHLC), which includes the Opening rate for the time interval). This chart provides clearly visible information about trading prices range during the time period (per unit) selected.
This kind of chart is based on an ancient Japanese method. The chart represents prices at their opening, high, low and closing rates, in a form of candles, for each time unit selected.
The empty (transparent) candles show increase, while the dark (full) ones show decrease.
The length of the body shows the range between opening and closing, While the whole candle (including top and bottom wicks) show the Whole range of trading prices for the selected time unit.
RSI - Relative Strength Index - a technical momentum indicator, devised by Welles Wilder, measures the relative changes between the higher and lower closing prices. RSI compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.
RS - average of N days up closes, divided by average of N days down closes
N - predetermined number of days
The RSI ranges from 0 to 100. An asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. Likewise, if the RSI approaches 30, it is an indication that the asset may be getting oversold and therefore likely to become undervalued. A trader using RSI should be aware that large surges and drops in the price of an asset will affect the RSI by creating false buy or sell signals. The RSI is best used as a valuable complement to other stock-picking tools.
A technical momentum indicator that compares an instrument's closing price to its price range over a given time period. The oscillator's sensitivity to market movements can be reduced by adjusting the time period, or by taking a moving average of the result.
%K = 100 * [(C - L14) / (H14 - L14)]
C= the most recent closing price;
L14= the low of the 14 previous trading sessions;
H14= the highest price traded during the same 14-day period.
The theory behind this indicator, based on George Lane's observations, is that in an upward-trending market, prices tend to close near their high, and during a downward-trending market, prices tend to close near their low. Transaction signals occur when the %K crosses through a three-period moving average called the "%D".
a range of price volatility named after John Bollinger, who invented them in the 1980s. They evolved from the concept of trading bands, and can be used to measure the relative height or depth of price. A band is plotted two standard deviations away from a simple moving average. As standard deviation is a measure of volatility, Bollinger Bands adjust themselves to market conditions. When the markets become more volatile, the bands widen (move further away from the average), and during less volatile periods, the bands contract (move closer to the average).
Bollinger Bands are one of the most popular technical analysis techniques. The closer prices move to the upper band, the more overbought is the market, and the closer prices move to the lower band, the more oversold is the market.
The Support level is the lowest price an instrument trades at over a period of time. The longer the price stays at a particular level, the stronger the support at that level. On the chart this is price level under the market where buying interest is sufficiently strong to overcome selling pressure. Some traders believe that the stronger the support at a given level, the less likely it will break below that level in the future.
The Resistance level is a price at which an instrument or market can trade, but which it cannot exceed, for a certain period of time. On the chart this is a price level over the market where selling pressure overcomes buying pressure, and a price advance is turned back.
Support / Resistance Breakout - when a price passes through and stays beyond an area of support or resistance.
an oscillator used to help determine when an investment instrument has been overbought and oversold. The Commodity Channel Index, first developed by Donald Lambert, quantifies the relationship between the asset's price, a moving average (MA) of the asset's price, and normal deviations (D) from that average. The CCI has seen substantial growth in popularity amongst technical investors; today's traders often use the indicator to determine cyclical trends in equities and currencies as well as commodities. The CCI, when used in conjunction with other oscillators, can be a valuable tool to identify potential peaks and valleys in the asset's price, and thus provide investors with reasonable evidence to estimate changes in the direction of price movement of the asset.
a method of identifying reversals and continuation patterns, this was discovered and introduced to the market through a series of published articles written by technical analyst Daniel L.Chesler, CMT. Used for determining market turning-points and continuations (also known as trending behavior). It is a simple pattern that can be viewed in market price data, using traditional bar charts, or Japanese candlestick charts.
is an oscillator designed to measure the rate of price change, not the actual price level. This oscillator consists of the net difference between the current closing price and the oldest closing price from a predetermined period. The formula for calculating the momentum (M) is: M = CCP - OCP, Where: CCP - current closing price and OCP - old closing price
Momentum and rate of change (ROC) are simple indicators showing the difference between today's closing price and the close N days ago. "Momentum" is simply the difference, and the ROC is a ratio expressed in percentage. They refer in general to prices continuing to trend. The momentum and ROC indicators show that by remaining positive, while an uptrend is sustained, or negative, while a downtrend is sustained. A crossing up through zero may be used as a signal to buy, or a crossing down through zero as a signal to sell. How high (or how low, when negative) the indicators get shows how strong the trend is.
Average Directional Movement Index Technical Indicator (ADX) helps to determine if there is a price trend. It was developed and described in detail by Welles Wilder in his book "New concepts in technical trading systems".
The simplest trading method based on the system of directional movement implies comparison of two direction indicators: the 14-period +DI one and the 14-period -DI. To do this, one either puts the charts of indicators one on top of the other, or +DI is subtracted from -DI. W. Wilder recommends buying when +DI is higher than -DI, and selling when +DI sinks lower than -DI.
To these simple commercial rules Wells Wilder added "a rule of points of extremum". It is used to eliminate false signals and decrease the number of deals. According to the principle of points of extremum, the "point of extremum" is the point when +DI and -DI cross each other. If +DI raises higher than -DI, this point will be the maximum price of the day when they cross. If +DI is lower than -DI, this point will be the minimum price of the day they cross.
The point of extremum is used then as the market entry level. Thus, after the signal to buy (+DI is higher than -DI) one must wait till the price has exceeded the point of extremum, and only then buy. However, if the price fails to exceed the level of the point of extremum, one should retain the short position.
are used to emphasize the direction of a trend and to smooth out price and volume fluctuations, or "noise", that can confuse interpretation. There are seven different types of moving averages:
The only significant difference between the various types of moving averages is the weight assigned to the most recent data. For example, a simple (arithmetic) moving average is calculated by adding the closing price of the instrument for a number of time periods, then dividing this total by the number of time periods.
The most popular method of interpreting a moving average is to compare the relationship between a moving average of the instrument's closing price, and the instrument's closing price itself.
Sell signal: when the instrument's price falls below its moving average
Buy signal: when the instrument's price rises above its moving average
The other technique is called the double crossover, which uses short-term and long-term averages. Typically, upward momentum is confirmed when a short-term average (e.g., 15-day) crosses above a longer-term average (e.g., 50-day). Downward momentum is confirmed when a short-term average crosses below a long-term average
a technical indicator, developed by Gerald Appel, used to detect swings in the price of financial instruments. The MACD is computed using two exponentially smoothed moving averages of the security's historical price, and is usually shown over a period of time on a chart. By then comparing the MACD to its own moving average (usually called the "signal line"), traders believe they can detect when the security is likely to rise or fall. MACD is frequently used in conjunction with other technical indicators such as the RSI (Relative Strength Index, see further down) and the stochastic oscillator (see further down).
In principle, Alligator Technical Indicator is a combination of Balance Lines (Moving Averages) that use fractal geometry and nonlinear dynamics.
Lips, Teeth and Jaw of the Alligator show the interaction of different time periods. As clear trends can be seen only 15 to 30 per cent of the time, it is essential to follow them and refrain from working on markets that fluctuate only within certain price periods.
When the Jaw, the Teeth and the Lips are closed or intertwined, it means the Alligator is going to sleep or is asleep already. As it sleeps, it gets hungrier and hungrier — the longer it will sleep, the hungrier it will wake up. The first thing it does after it wakes up is to open its mouth and yawn. Then the smell of food comes to its nostrils: flesh of a bull or flesh of a bear, and the Alligator starts to hunt it. Having eaten enough to feel quite full, the Alligator starts to lose the interest to the food/price (Balance Lines join together) — this is the time to fix the profit.
MEDIAN PRICE = (HIGH + LOW) / 2
ALLIGATORS JAW = SMMA (MEDEAN PRICE, 13, 8)
ALLIGATORS TEETH = SMMA (MEDEAN PRICE, 8, 5)
ALLIGATORS LIPS = SMMA (MEDEAN PRICE, 5, 3)
MEDIAN PRICE — median price;
HIGH — the highest price of the bar;
LOW — the lowest price of the bar;
SMMA (A, B, C) — smoothed moving average. A parameter is for data to be smoothed, B is the smoothing period, C is shift to future. For example, SMMA (MEDIAN PRICE, 5, 3) means that the smoothed moving average will be calculated on the median price, smoothing period being equal to 5 bars and shift being 3;
ALLIGATORS JAW — Alligator's jaws (blue line);
ALLIGATORS TEETH — Alligator's teeth (red line);
ALLIGATORS LIPS — Alligator's lips (green line).
ADX = SUM[(+DI-(-DI))/(+DI+(-DI)), N]/N
N — the number of periods used in the calculation
Ichimoku Kinko Hyo Technical Indicator is predefined to characterize the market Trend, Support and Resistance Levels, and to generate signals of buying and selling. This indicator works best at weekly and daily charts.
When defining the dimension of parameters, four time intervals of different length are used. The values of individual lines composing this indicator are based on these intervals:
Chinkou Span shows the closing price of the current candle shifted backwards by the value of the second time interval. The distance between the Senkou lines is hatched with another color and called "cloud". If the price is between these lines, the market should be considered as non-trend, and then the cloud margins form the support and resistance levels.
Kijun-sen is used as an indicator of the market movement. If the price is higher than this indicator, the prices will probably continue to increase. When the price traverses this line the further trend changing is possible. Another kind of using the Kijun-sen is giving signals. Signal to buy is generated when the Tenkan-sen line traverses the Kijun-sen in the bottom-up direction. Top-down direction is the signal to sell. Tenkan-sen is used as an indicator of the market trend. If this line increases or decreases, the trend exists. When it goes horizontally, it means that the market has come into the channel.
Standard Deviation — value of the market volatility measurement. This indicator describes the range of price fluctuations relative to simple moving average. So, if the value of this indicator is high, the market is volatile, and prices of bars are rather spread relative to the moving average. If the indicator value is low, the market can described as having a low volatility, and prices of bars are rather close to the moving average.
Normally, this indicator is used as a constituent of other indicators. Thus, when calculating Bollinger Bands, one has to add the symbol standard deviation value to its moving average.
StdDev = SQRT (SUM (CLOSE - SMA (CLOSE, N), N)^2)/N
SQRT — square root;
SUM (..., N) — sum within N periods;
SMA (..., N) — simple moving average having the period of N;
N — calculation period.
Up trend line - straight line drawn upward to the right along successive reaction lows.
Down trend line - straight line has drawn downwards to the right along successive rally peaks.
Two points are needed to draw the trend line, and a third point to make it valid trend line. Trend lines are used in many ways by traders. One way is that when price returns to an existing principal trend line' it may be an opportunity to open new positions in the direction of the trend in the belief that the trend line will hold and the trend will continue further. A second way is that when price action breaks through the principal trend line of an existing trend, it is evidence that the trend may be going to fail, and a trader may consider trading in the opposite direction to the existing trend, or exiting positions in the direction of the trend.
Leonardo Pisano Bogollo, (c. 1170 - c. 1250)also known as Leonardo of Pisa, Leonardo Pisano, Leonardo Bonacci, Leonardo Fibonacci, or, most commonly, simply Fibonacci, was an Italian mathematician, considered by some "the most talented western mathematician of the Middle Ages.
Fibonacci is best known to the modern world for
. The spreading of the Hindu-Arabic numeral system in Europe, primarily through the publication in the early 13th century of his Book of Calculation, the Liber Abaci.
The Hindu-Arabic numeral system or Hindu numeral system is a positional decimal numeral system developed by the 9th century by Indian mathematicians, adopted by Persian (Al-Khwarizmi's circa 825 book On the Calculation with Hindu Numerals) and Arabic mathematicians (Al-Kindi's circa 830 volumes On the Use of the Indian Numerals), and spread to the western world by the High Middle Ages.
The system is based on ten (originally nine) different glyphs. The symbols (glyphs) used to represent the system are in principle independent of the system itself. The glyphs in actual use are descended from Indian Brahmi numerals, and have split into various typographical variants since the Middle Ages.
These symbol sets can be divided into three main families: the Indian numerals used in India, the Eastern Arabic numerals used in Egypt and the Middle East and the West Arabic numerals used in the Maghreb and in Europe.
. A number sequence named after him known as the Fibonacci numbers, which he did not discover but used as an example in the Liber Abaci.
By definition, the first two Fibonacci numbers are 0 and 1, and each subsequent number is the sum of the previous two. Some sources omit the initial 0, instead beginning the sequence with two 1s.
The Fibonacci number sequence (1, 1, 2, 3, 5, 8, 13, 21, 34 ...) is constructed by adding the first two numbers to arrive at the third. The ratio of any number to the next larger number is 61.8%, which is a popular Fibonacci retracement number. The inverse of 61.8%, which is 38.2%, is also used as a Fibonacci retracement number (as well as extensions of that ratio, 161.8%, 261.8%). Wave patterns and behavior, identified in Forex trading, correlate (to some extent) with relations within the Fibonacci series. The tool is used in technical analysis that combines various numbers of Fibonacci retracement, all of which are drawn from different highs and lows. Fibonacci clusters are indicators which are usually found on the side of a price chart and look like a series of horizontal bars with various degrees of shading. Each retracement level that overlaps with another makes the horizontal bar on the side darker at that price level. The most significant levels of support and resistances are found where the Fibonacci cluster is the darkest. This tool helps gauging the relative strength of the support or resistance of various price levels in one quick glance. Traders often pay close attention to the Volume around the identified levels to confirm the strength of the Support/resistance.
W.D. Gann was a stock and a commodity trader working in the ‘50s, who reputedly made over $50 million in the markets. He made his fortune using methods that he developed for trading instruments based on relationships between price movement and time, known as time/price equivalents. There is no easy explanation for Gann's methods, but in essence he used angles in charts to determine support and resistance areas, and to predict the times of future trend changes. He also used lines in charts to predict support and resistance areas.
The Elliott Wave principle was discovered in the late 1920s by Ralph Nelson Elliott. He has discovered that there is no chaos in the stock markets, but that markets move in repetitive cycles, which reflect the actions of humans caused by their emotions or mass psychology. Elliott contended that the ebb and flow of mass psychology always revealed itself in the same repetitive patterns, which subdivide in so called waves.
In part Elliott based his work on the Dow Theory, which also defines price movement in terms of waves, but Elliott has discovered the fractal nature of market action. Therefore Elliott could analyze markets in greater depth, identifying the specific characteristics of wave patterns and making detailed market predictions based on the patterns he had identified.
Fractals are mathematical structures, which on an ever smaller scale infinitely repeat themselves. The patterns that Elliott discovered are built in the same way. An impulsive wave, which goes with the main trend, always shows five waves in its pattern. On a smaller scale, within each of the impulsive waves of the before mentioned impulse, again five waves will be found. In this smaller pattern, the same pattern repeats itself ad infinitum (these ever smaller patterns are labeled as different wave degrees in the Elliott Wave Principle)
Only much later fractals have been recognized by scientists. In the 1980s the scientist Mandelbrot proved the existence of fractals in his book "the Fractal Geometry of Nature". He recognized the fractal structure in all sort of objects and life forms, a phenomena Elliott already understood in the 1930s.
In the 70s the Wave Principle gained popularity through the work of Frost and Prechter. They published a legendary book ( a must for every wave student) on the Elliott Wave (Elliott Wave Principle...key to stock market profits, 1978), wherein they predicted, being in the middle of the crisis of the 70s, the great bull market of the 1980s. Not only did they correctly forecast the bull market but also Robert R. Prechter predicted the crash of 1987 in time and pinpointed the high exactly.
Only after years of study, Elliott learned to detect these recurring patterns in the stock market. Apart from these patterns Elliott also based his market forecasts on Fibonacci numbers. Everything he knew has been published in several books, which lay the foundation for people like Bolton, Frost, Prechter and the professional trader who designed this Elliott Wave software, to make profitable forecasts, not only for stock markets, but for all financial markets.
Bull trend (up-trend: a series of highs and lows, where each high is higher than the Previous one);
Bear trend (down-trend: a series of highs and lows, where each low is lower than the previous one);
Treading trend (horizontal-trend: a series of highs and lows, where peaks and lows are around the same as the previous peaks and lows).
Moving averages are used to smooth price information in order to confirm trends and support-and-resistance levels. They are also useful in deciding on a trading strategy, particularly in futures trading or a market with a strong up or down trend. Recognizing a trend may be done using standard deviation, which is a measure of volatility. Bollinger Bands, for example, illustrate trends with this approach. When the markets become more volatile, the bands widen (move further away from the average), while during less volatile periods, the bands contract (move closer to the average).
Gaps are spaces left on the bar chart where no trading has taken place. Gaps can be created by factors such as regular buying or selling pressure, earnings announcements, a change in an analyst's outlook or any other type of news release.
An up gap is formed when the lowest price on a trading day is higher than the highest high of the previous day. A down gap is formed when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a sign of market strength, while a down gap is a sign of market weakness. A breakaway gap is a price gap that forms on the completion of an important price pattern. It usually signals the beginning of an important price move. A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For that reason, it is also called a measuring gap. An exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.
Technical analysis can be used to project movements of any asset (which is priced under demand/supply forces) available for trade in the Capital market.
Technical analysis focuses on what is happening, as opposed to what has previously happened, and is therefore valid at any price level.
The technical approach concentrates on prices, which neutralizes external factors. Pure technical analysis is based on objective tools (charts, tables) while disregarding emotions and other factors.
Signaling indicators sometimes point to the imminent end of a trend, before it shows in the actual market. Accordingly, the trader can maintain profit or minimize losses.
Some critics claim that the Dow approach ("prices are not random") is quite weak, since today's prices do not necessarily project future prices. The critics claim that signals about the changing of a trend appear too late, often after the change had already taken place. Therefore, traders who rely on technical analysis react too late, hence losing about 1/3 of the fluctuations. Analysis made in short time intervals may be exposed to "noise", and may result in a misreading of market directions.
The use of most patterns has been widely publicized in the last several years. Many traders are quite familiar with these patterns and often act on them in concern. This creates a self-fulfilling prophecy, as waves of buying or selling are created in response to "bullish" or "bearish" patterns.
Technical analysis is a great forecasting tool to control the psychology of the trader to take tough decision on position while trading. Many instances historically these tools proved and made windfall profit to the individuals those who had applied systematically with great patience.
As a trader, one must follow both fundamental and technical analysis to understand real seniors of the market movement to take investment decision. To have a complete knowledge as a forex professional trader please go to our fundamental analysis part.
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