Thursday, June 29, 2017

Understanding Forex Charts

understand forex chartsFor a currency trader, nothing creates a better or more valuable picture of price data then a price chart. This visual representation is the primary tool used by traders to develop directional opinions and to forecast future movements in price. Understanding forex charts and how to use them properly is an important step in the educational process of any new trader. Elaborate theories and complex algorithms, despite their potential for being profitable often lose their perspective to even the most astute trader. Yet their predictive theory can often be better understood through the use of a simple chart to look at.

Price Charts are a Picture of the Past

Price charts can allow us at a glance to identify trends, possible reversals, points of entry and times to exit. As technical traders, we can also use forex charts to tell us when we are wrong, or at what price point we should expect a profit target to be reached. The picture that a forex chart provides us can be used to establish many, or in some cases all of our trading decisions, with objectivity… making it a worthy skill to develop for any student of the markets.

Technical analysis, or chart reading can be broken down into 3 specific categories; Market Structure, Indicators, and Pattern Recognition. By understanding these 3 areas you can begin  to understand and formulate for yourself how to begin combining all or some of these into a logical, cohesive trading strategy. Let’s talk about each of these categories now!

Market Structure

Many traders tend to focus on specific indicators or chart patterns without remembering the most basic and important purpose of a price chart. Charts are primarily designed to show traders the highs and the lows within the charted time frame. Identifying these highs and lows are extremely important to understanding turning points and whether these turning points are reversals, pull backs, or reflecting a range bound market. To do this, we must first identify the highest high and the lowest low on the chart. These are easy to identify because we are looking for an absolute high and an absolute low, within a specified period of time as reflected on the chart.

For example purposes, we will identify these as  the “long term high” and the “long term low”. However, between the long term high and the long term low you will generally find “intermediate term highs” and “intermediate term lows”. These represent turning points that are contained within the previously identified price points. OK… drilling down we can now begin looking for highs and lows that are contained within the intermediate turning points as well. By forcing yourself to look for and identify these swings in price, you can begin to understand the market structure and how to begin establishing some simple but effective strategies for buying and selling.

Indicators

Indicators are best described as mathematical calculations of data `points used as tools to help forecast future price action. As complicated as that may sound, most indicators are easy to understand once you look at the so-called fancy math behind them. For instance, a 20 day, simple moving average can be calculated by taking 20 days of price data and dividing it by 20. This final number represents the average price over 20 days and can be used to provide a better visual understanding of trend direction for the currency pair you are trading. For instance, if todays price is above the 20 day moving average, and todays moving average is greater then yesterdays moving average, most analysts would interpret that as bullish.

Other indicators can be used to determine the velocity or momentum of price action, such as stochastic , momentum, and/or relative strength indicators. These indicators, often referred to as oscillators help traders gauge the strength of a currency pairs trend and can also show possible turning points or exhaustion of that trend.forex indicators

Although each of these represent a more complicated mathematical formula then the moving average example, a basic understanding of their purpose and how the formula uses the data to plot it’s calculation are still within the reach of  mathematically  challenged people like me! Indicators are an important part of your trading arsenal, they are the truth serum in chart reading and can be used in a variety of combinations.

Pattern Recognition

Chart patterns represent another method for traders to forecast price. Developing a keen eye for these is also important to understanding forex charts. Chart patterns can be used to identify periods of sideways movements, known as consolidations, reversals, break-outs, break-downs, pull-backs, support / resistance, tops / bottoms, and continuations of trend. Some patterns represent only 1 day of price data, while others can take months to unfold.

As an example, a “key reversal” or a “doji” (2 different patterns) encompass one day (or time period) of price action, while the classic “cup and handle” (a continuation pattern), or the well known “head and shoulders” (a reversal pattern), can take weeks or months before it is considered valid. Pattern recognition can also provide the technician with profit targets by measuring the length between 2 price points, as well as the expected time frame by analyzing the amount of time certain patterns take to unfold.

Chart patterns can also provide the forex trader with a visual of where support and resistance levels are, they assist us in drawing trend lines or by identifying key areas for consideration when determining where to place our stops, when to enter, and of course, when to get out.

Putting It All Together

As you can see, by understanding the overall market structure, a handful of indicators, and developing your pattern recognition skills you will be giving yourself a tremendous advantage over most speculators.  These skills will provide the foundation a trader needs to begin developing there own trading plan and also to be able to look at the currency pair you are trading and know what is going on and why. At first, much of this will appear as Greek… but I assure you that as you continue to study, these concepts will eventually become English and you will find yourself, one day, understanding forex charts better then 99% of the population.

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