Technical Aspects of Forex Trading
Every day many new traders enter the financial markets, they use a variety of methods to trade which can be dismaying at times. Traders may use fundamental analysis or technical analysis to initiate their trades in financial markets. So, how do we build a trading strategy? Complimentary to Fundamental Analysis is Technical Analysis. This is the study of market price and volume of trades. This form of analysis does not take into account the company, commodity, or market but instead focuses on the historical market data which helps us in predicting the future market direction.
Technical Analysis is a technique of inspecting and anticipating price movements in the financial markets by using historical price charts. If a trader can identify or read these past market patterns, they can frame a fairly accurate prediction of future price directions. Technical Analysis is not an exact science and nevertheless, many people use it to trade in the financial markets. A Technical Trader always works with three key assumptions.
Firstly, Market price action leads everything else which means markets are very efficient and effective machines which in seconds of news breaking investment banks and professional traders are buying and selling accordingly, and the instrument’s true value is reflected very quickly in the price. This makes it difficult for no more traders to effectively make money just from news flows. Secondly, Prices move in trends and tend to follow the simple patterns every period of time.
Finally, History often repeats itself and technical traders should remember that the prices that were important in the past can become important again and by ‘Important’ we mean they have reached important levels to bring about a turnaround in price.
The first step in technical analysis is to learn to look at Candlestick charts. Most new traders may even look at a line chart when checking the price of an instrument over a specific period of time. A line chart contains two closing points with a line joining the two points.
The above chart represents the Nifty Index in which we selected the time frame of 3 months in a candlestick chart format and the results were recorded on a daily basis. This type of chart contains four pieces of information for the given time period i.e., the opening price, the closing price, the highest price, and the lowest price. The candles in the above graph with red and green color are described below.
The green candle signifies that the prices have gone up from the opening time of the candle formation or signifies bullishness whereas the red candle signifies the prices have gone down from the opening time of candle formation and signifies bearishness. In simple words, we can say that these candlestick patterns give a trader the clarity about the behavior of buyers and sellers in the market at that particular period of time.
These high and low levels cannot be seen clearly in a line chart so that is why candlestick charting is done so that we do not miss any price higher or lower levels. The support and resistance is another form of technical analysis, although it is an important form of technical analysis. The Support level is the level to which the price of an instrument may drop before rising again.
For example, if a currency falls from 5 US Dollar to 4 US Dollar, then rise to 7 US Dollar, then again falls to 4 US Dollar and rebounds back; it means the price of 4 US Dollar is acting as a support for that currency. And remember that we are working on the assumption that history repeats itself. The resistance level is the level at which the price of an instrument may reach before the price falls.
For example, if the price of currency keeps hitting 8 US dollars then falling down again so it’s possible if the price reaches 8 US dollars again it may fall back down again. So, how do we identify if a pricing counter is a support or resistance? We have to plot the trend over the duration we specified and identify the previous highs and previous lows and the historical data. Traders use drawing tools such as horizontal lines, trend lines, and Fibonacci levels to identify the well-known chart patterns. To show support or resistance we may draw a trend line which may be an uptrend, downtrend, or a sideways trend. These chart patterns show a trader of the strength and weaknesses of the buyer and sellers in the market.
Technical analysis indicators are used to understand the market conditions like overbought or oversold zones or falling and rising momentum in the market. There are many ways to perform technical analysis which may vary from trader to trader and these technical patterns help the trader to identify the market condition as well as the proper entry and exit points for entering a trade. Proper use of technical analysis can help in risk management in trade execution.
Remember, try to always do research about the instrument of interest before entering any trading investment and ensure additional research about the new investment is carried out. Technical analysis and the tools available for research enable us to make a more informed decision about any trade.