Technical analysis can provide you with better timing and risk control in forex trading. In this article, we will go through the basics of this analysis method so you can take your first steps on your path to becoming a profitable forex trader.
What is a chart?
A price chart (from here on called a “chart”) is a representation of the movement in a stock price, index, commodity or currency traded in a market over a given period of time. Observing movements in price and volume over time can provide you with a lot of information, and this is the basis of what is known as Technical Analysis.
Microeconomics in practice
It is often useful to go back to the basics when describing a problem, so let’s do that. The forex market works by the fact that buyers and sellers of currencies meet and agree on a price to exchange one currency for another. Such a price point will, in standard microeconomic theory, represent an “equilibrium” between supply and demand.
If demand is higher than the supply at a given price, prices will usually rise to find a new balance, and the opposite happens if the supply is greater than the demand. This is how an entire market economy is made up. In the forex markets we observe this daily as prices trend either up or down.
You can also have periods where prices consolidate at certain levels. This can be a sign that the market is in a state of equilibrium, and new information is needed to drive prices further. It may also be a result of buy or sell orders placed in the market at these price levels, which must be absorbed before the market continues in the direction it had prior to the consolidation.
Technical, fundamental and quantitative analysis
When you are starting out on your trading journey, it is important that you choose the tool that are best suited for the purpose you are going to use it for. In general, analysis methods in the markets are divided into technical, fundamental and quantitative analysis.
Each method has its hardcore proponents, but don’t forget that in reality these are simply three different ways of looking at the same underlying market. If you break down the different methods and look at how they are made up, you will find that there is also a great deal of overlap between them. Professional traders are usually well-versed with all three of these methods.
Charts – more than just the price
As already mentioned, a basic price chart always shows the price over a certain period of time. A daily chart thus shows the historical opening, closing, high and low prices each day, while an hourly chart can show the same per hour.
By using price alone as the data input, it is possible to calculate a number of different indicators to use in technical analysis. Below I have listed a few of them, but remember that you should not fall in love with any of these indicators. The most important thing in trading will always be the price itself.
Moving average – A continuously calculated average of the price over a given time period, shown as a line in the same chart as the price. 50, 100 and 200 days moving average are most commonly used. They can be used to define a trend, or even provide buy or sell signals when two or more moving averages are used in combination with each other.
Oscillators – Many different indicators fall into this category. Most commonly known is the Relative Strength Index (RSI). This is a number that fluctuates between 0 and 100 and shows how much the price has trended upwards or downwards on a scale where 50 is considered neutral. Readings above 70 are often considered “over-bought”, while below 30 indicates “over-sold.”
ATR – Average True Range – This indicator may not be as well-known among retail traders, but is often referred to by professional traders. The ATR shows how much an asset moves on average during one day, taking into account intraday movement between high and low, as well as how much the asset moves relative to yesterday’s closing. It is often used to define a stop-loss level for trend traders.
Markets and speculation
As long as there have been markets with quoted prices, there has been speculation by actors in the market. You can even read about this in the history of the Italian city-states of Venice, Florence and Genoa in the 1300s, and the Verona statutes in 1318 describe a futures market for commodity trading.
However, with the establishment of the stock exchange in Amsterdam in the Netherlands in 1602, financial speculation took a form that was more similar to the way it is still being done today, with various market actors buying and selling securities solely for the purpose of making a profit.