Technical Analysis Introduction for Forex
This article will focus on Technical Analysis. This field of knowledge is probably the largest in the Forex trading world. This article will explain what Technical Analysis is and what it does. I will also give you a basic technical trading strategy.There are two main types of analyzing the Forex market. The first type is technical analysis. Technical analysis is a way of using historical price data in different ways to predict the future price of a currency pair. Technical analysis relies on price charts and various technical indicators to make predictions. The main assumption of Technical Analysis is that the historical price data reveals patterns that repeat themselves over time. Fundamental analysis is also a popular way of analyzing the Forex market. Fundamental analysis examines different facts about the economy to predict price movements. Fundamental Analysis Introduction for Forex will concentrate on fundamental analysis exclusively.
I am explaining technical analysis first because it is the easiest and most precise way of trading the Forex market. "The numbers don't lie" is a phrase that applies more to technical analysis than to the fundamental approach. Technical analysis can be learned much faster than fundamental analysis and requires less expertise.
I mentioned above that technical analysis is based on technical indicators. These indicators make different mathematical calculations and display the results on a price chart. The skilled Forex trader interprets these indicators and makes trading decisions. So how do you become a skilled Forex trader, friend? Read on to find out. The most basic technical indicator is one that you can draw with your own hand. I will simply explain this indicator, but you will not use it. This basic indicator was used early in the stock market, and is still used today. This indicator is known as a "trend line". To draw a "trend line" you simply:
- Print out an historical price chart for a given time interval of a currency pair.
- Draw a line connecting two or more parts of a graph that have higher lows, or lower highs.
Poof! Now you have a trend line. This trend line represents the basic price direction of the currency pair. When the price of the currency pair breaks through the trend line in the direction opposite of the trend, you would expect a reversal. By reversal I mean this:
- If the prior trend was upward and the price broke through the trend line moving down, this would indicate a new downward trend using the trend line method.
- If the prior trend was downward and the price broke through the trend line moving up, this would indicate a new upward trend using the trend line method.
Suppose you are monitoring the EUR/USD (a popular currency pair). You draw a trend line connecting 3 points where higher lows are reached than previously on the chart. After you draw the line, you notice that all of the price data on the chart so far falls below the trend line you have drawn. The trend line is acting like a "floor". The floor appears to be a boundary that the price will not cross.
So now you wait until the price crosses the boundary. A few periods later you notice that the trend line has been broken when the EUR/USD fell below it. So now you would expect the price to go even lower because the "trend line" method suggests that an old floor will act as a new ceiling. So now you can expect all of
the prices to be below the trend line once it has been broken. Once the trend line is broken, the prices should stay below the trend line. This method is not very scientific. A lot of the method depends on how you draw your trend line. I have also given you a simplistic version of the trend line method. There is a little more to it. Because the trend line method is not very scientific (or accurate) better methods have been developed. Some changes were made to the trend line philosophy and many people called for a more precise method. There are actually many more precise methods available today. The next method was not a practical candidate to replace trend lines until the computers reached the sophistication of the mid 1990's.
the prices to be below the trend line once it has been broken. Once the trend line is broken, the prices should stay below the trend line. This method is not very scientific. A lot of the method depends on how you draw your trend line. I have also given you a simplistic version of the trend line method. There is a little more to it. Because the trend line method is not very scientific (or accurate) better methods have been developed. Some changes were made to the trend line philosophy and many people called for a more precise method. There are actually many more precise methods available today. The next method was not a practical candidate to replace trend lines until the computers reached the sophistication of the mid 1990's.
The Simple Moving Average (SMA) is a theoretical extension of the trend line concept. The Simple Moving Average is plotted on a graph by the charting program for the Forex market data. The SMA takes the average of the close price of a given number of the last few periods. Any number of periods can be selected. You can have an SMA5 or an SMA20. An SMA5 will take an average of the previous 5 close prices on the chart and will plot it on the chart alongside the other price data. Each bar will use the previous 5 bars worth of data to calculate a point and plot it on the graph.
If the SMA is generated using a large number of periods (like an SMA50 or SMA75), you could interpret it similarly to the trend line. But if you select "faster" SMA's (like an SMA5 or SMA20), you need to use a different strategy.
I am about to give you a strategy using the SMA. In Forex Demo Account Setup, I will tell you how to set up a free demo account and begin using this strategy for practice trades. This strategy is a very basic one. It does not have a high degree of accuracy, but it is very easy to do and it is fun. It is a good technique to begin trading with. I want you to keep in mind that there are better strategies out there.
The SMA crossover method. After you have set up your free demo account (Forex Demo Account Setup), you need to open the charting software. The SMA is one of the most commonly used indicators and can be found in almost every charting package out there. When you plot the SMA, you will be able to select a line color to plot it. Make sure to use a different color than the actual prices on the chart.
Step 1: Plot an EMA5 using blue (or any color you like)
Step 2: Plot an EMA20 using red (or any color that is different than step 1's color)
You now have 2 SMA's plotted on the chart. You also have two signals.
Buy signal: When the SMA5 crosses the SMA20 moving up ward.
Sell signal: When the SMA5 crosses the SMA20 moving down ward.
The beauty of this method is that the price of the currency pair can not go up significantly without triggering the buy signal. In other words - if the currency pair begins to trend up, then the buy signal must be triggered. The opposite is also true - if the currency pair begins to trend down, then the sell signal must be triggered. The only time where this system fails is when there are false alarms. Sometimes the currency will act like it is going to trend up and then it will trend back down.
Here is a way to see how the SMA's predict price movements. You should open up some charts and put on the SMA5 and SMA20 overlays. You can then look at the times where the price fell/rose significantly. What did the SMA look like near the beginning of the price movement? What did it look like after? By viewing how the SMA reacted in the past you will get an intuitive feeling for how it will act in the future after an SMA crossover.
The SMA crossover method will work best in longer time frames. If you attempt to use it for tick-by-tick day trading, it will probably only produce losses. This method works better for trades that last weeks, or months. I have only shown you this method so you can trade it for fun. I strictly want to caution you not to trade any real money using this system ever, unless you add tips from the Forexezine to it and perfect it for yourself.
Insider Secrets of Online Currency Trading will provide you with other techniques in the future. This is an easy one to get started with. I have also personally developed 2 trading strategies that utilize more powerful techniques. In the next article I will let you know what fundamental analysis is and some of the basic measures it considers.The 5thForex Demo Account Setup gives you what you need to understand and open a demo account.
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Insider Secrets of Online Currency Trading
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