Technical Analysis 1
1. Introduction
Technical analysis is a method of evaluating a market or financial product by studying information provided by trading activity, such as price and volume, with a view to predicting future activity. It typically involves the study of price charts combined with technical indicators, and is based on 3 assumptions:
- Any factor that can possibly influence the price – be it fundamental, economic or psychological, is already reflected in the price itself.
- Prices move in trends; once a trend is established, future price movement will more likely than not be in the direction of the trend.
- History repeats itself; hence rules and techniques which were effective in the past in predicting price action will be just as effective now and in the future.
2. Charts
The most fundamental tool in technical analysis is the price chart; this is simply a graphical representation of price over time. Example 1 shows a line chart of EURUSD with a ‘daily’ period, where a line connects each point on the graph representing the closing price of EURUSD on each trading day. The horizontal or x-axis shows the date or time period, while the price is shown on the vertical or y-axis.
The time period can range from seconds to years; although the 5m (5 minute), hourly, daily and weekly charts are the most commonly used. The shorter the period, the more detailed the chart – this is useful for day traders who open and close positions several times within a day – while a longer period gives a clearer picture of long-term trends.
Common Types of Charts
Line Charts
The most basic chart is the line chart, seen in Example 1. It shows a line joining the closing prices over a set time period. Although line charts do not provide as much visual information as the other chart types, it provides a simple graphical representation of the general trend.
Line Charts (Example 1)
Bar Charts
The most popular price chart is the bar chart, seen in Example 2. Each ‘bar’ shows the opening price (a dash to the left of the bar), highest price (the maximum point of the bar), lowest price (the minimum point of the bar) and closing price (a dash to the right of the bar) for a given time period, in this case 5min.
Bar Charts (Example 2)
Candlestick Charts
A candlestick chart provides the same information as a bar chart, represented differently. A thin vertical line shows the trading range for a given period (highest price to lowest price), while a wider ‘body’ shows the difference between the opening and closing price. Candlestick charts typically employ the use of 2 different colors to show whether the closing price was higher or lower than the opening price. In example 3, a red ‘candlestick’ shows that the closing price was lower than the opening price; with the top of the ‘body’ representing opening price and the bottom the closing price. A blue ‘candlestick’ shows that the closing price was higher than the opening price; with the top of the ‘body’ representing the closing price and the bottom the opening price.
Candlestick Charts (Example 3)
3. Analyzing Charts
Trends
One of the basic assumptions in technical analysis is that prices move in trends. Charts are studied to ascertain the direction of a trend; i.e. the general direction of the movement of prices over time.
Trends may be classified as up, down and sideways, with the latter indicating a lack of general direction.
Trends may also be long-term, intermediate, or short-term. Long-term or major trends usually last more than a year, while intermediate trends may last for months and short-term trends last for less than a month. Within these trends are usually trends of a shorter duration which move in the opposite direction of the longer-term trend.
To indicate a trend, a trendline is drawn; this is a straight line joining several significant tops or bottoms. A trendline helps to define support and resistance levels.
Support & Resistance
A support line connects the significant lows in a chart. This represents levels of support at which sellers are unwilling or unable to sell at lower levels and prices begin to move higher. Traders tend to buy when prices move towards support levels or sell when prices trade lower through support levels.
A resistance line connects the significant highs in a chart. This represents levels at which buyers are unwilling or unable to buy at higher levels and prices begin to move lower. Traders typically sell as prices move towards resistance levels or buy when prices trade higher through resistance levels
Support
Resistance
4. Chart Patterns
Traders detect distinct formations on charts to help define current trends and predict future price action. The use of chart patterns is based on the assumption that history repeats itself; that patterns repeat themselves and indicate a high possibility of prices moving in a certain direction. Numerous chart patterns have been identified and named throughout the years, but no chart pattern can indicate with 100% accuracy where prices will be headed next. This is one of the reasons why charting is sometimes considered more an art than a science. Here we show some of the more common patterns.
Five Basic Chart Patterns You Need To Know
We believe there are profits to be made in currency trading. If you are able to identify the right chart patterns using the right tools, you can achieve consistent profits in currency trading.
We introduce you to five of the most powerful, profitable patterns in currency trading. You’ll learn some basic skills you need to recognize proven money-making patterns, and you’ll get to see these patterns in action.
Discover How To:
- Identify profitable charts pattern
- Minimize your risk
- Maximize your return in up and down markets
One: The Symmetrical Triangle
You’ll recognize the symmetrical triangle pattern when you see a currency’s price gyrating up and down and converging towards a single point. Its back and forth oscillations will become smaller and smaller until the currency reaches a critical price, breaks out of the pattern, and moves drastically up or down.
The symmetrical triangle pattern is formed when traders are unsure of a currency’s value. Once the pattern is broken, traders jump on the bandwagon, selling or buying on the breakout.
Symmetrical Triangle Pattern
To form your symmetrical triangle pattern, draw two converging trendlines that bound the high and low prices. Your trendlines should form (you guessed it) a symmetrical triangle, lying on its side.
How to Profit from Symmetrical Triangles
Symmetrical triangles are very reliable. You can profit from upwards or downwards breakouts. You’ll learn more about how to benefit from downtrends when we talk about maximizing profits.
If you see a symmetrical triangle forming, watch it closely. The sooner you catch the breakout, the more money you stand to make.
Watch For:
• Sideways movement, a period of rest, before the breakout.
• Price of the asset traveling between two converging trendlines.
• Breakout ¾ of the way to the apex.
Set Your Target Price:
As with all patterns, knowing when to get out is as important as knowing when to get in. Your target price is the safest time to sell, even if it looks like the trend may be continuing.
For symmetrical triangles, sell your currency pair at a target price of:
• Entry price plus the pattern’s height for an upward breakout.
• Entry price minus the pattern’s height for a downward breakout.
Typical Triangles in Action
Two: Ascending and Descending Triangles
When you notice a currency pair has a series of increasing troughs and the price is unable to break through a price barrier, chances are you are witnessing the birth of an ascending triangle pattern.
Ascending Triangle Pattern
Confirm your ascending triangle pattern by drawing a horizontal line tracing the upper price barrier and a diagonal line tracing the series of ascending troughs.
The descending triangles is the bearish counterpart to the ascending triangle.
Descending Triangle Pattern
Confirm your descending triangle by drawing a horizontal line tracing the lower price barrier and a diagonal line tracing the series of descending troughs.
The ascending and descending patterns indicate a currency pair is increasing or decreasing in demand. The currency meets a level of support or resistance (the horizontal trendline) several times before breaking out and continuing in the direction of the developing up or down pattern.
How to Profit from Ascending and Descending Triangles
Ascending and descending triangles are short-term trader favorites, because the trends allow short-term traders to earn from the same sharp price increase that long-term traders have been waiting for. Rather than holding on to a long or short position for months or years before you finally see a big payday, you can buy and hold for only a period of days and reap in the same returns as the long-term traders.
As with many of our favorite patterns, when you learn to identify ascending and descending triangles, you can profit from upwards or downwards breakouts. That way, you’ll earn a healthy profit regardless of where the market is going.
Watch For:
• An ascending or descending pattern forming over three to four weeks.
Set Your Target Price:
For ascending and descending triangles, sell your stock at a target price of:
• Entry price plus the pattern’s height for an upward breakout.
• Entry price minus the pattern’s height for a downward breakout.
Ascending and Descending Triangles in Action
Ascending and descending triangles are some of our most popular patterns, because their features are so clear and the breakouts are almost always fast and furious.
Three: Head and Shoulders
The head and shoulders pattern is a prevailing pattern among short seller (bearish) traders who profit from downtrends. After three peaks, the currency pair plummets, offering a textbook, high-return opportunity to traders who catch the trend early.
Head and Shoulders Pattern
Head and shoulder patterns are characterized by a large peak bordered on either side by two smaller peaks. Draw one trendline, called the neckline, connecting the bottom of the two troughs.
The first trough is a signal that buying demand is starting to weaken. Traders who believe the currency pair is undervalued respond with a buying frenzy, followed by a flood of selling when traders fear the currency pair has run too high (overbought). This decline is followed by another buying streak which fizzles out early. Finally, the currency pair declines to its true worth below the original price.
How to Profit from the Head and Shoulders Pattern
• Short sell as soon as the price moves below the neckline after the descent from the right shoulder.
Set Your Target Price:
For the head and shoulders pattern, take profit near the target price of:
• Entry price minus the pattern’s height (distance from the top of the head to the neckline).
Head and Shoulders Pattern in Action
Four and Five: Triple and Double Bottoms and Tops
When you see a W or M pattern forming, you may have just discovered a money-making double bottom or double top pattern. These patterns are common reversal patterns used to suggest the current currency trend may be likely to shift.
But don’t panic if your double bottom or double top patterns do not develop as you had originally thought. You haven’t lost your chance for cash. If your W or M pattern reverses for a fourth time, you could now be working with the profitable triple bottom or triple top.
Double Bottom Pattern
Double Bottom Pattern
A small peak is surrounded by two equal troughs.
Buy When:
The price exceeds the middle-peak price.
Watch For:
A price increase of 10% to 20% from the first trough to the middle peak. Two equal lows, not to differ by more than 3% or 4%.
Set Your Target Price:
For the double bottom pattern, sell (take profit) your currency at a target price of:
• Entry price plus the pattern’s height (distance from the peak to the bottom of the lowest trough).
Double Bottom Pattern
Double Top Pattern
Double Top Pattern
A small trough is surrounded by two equal peaks.
Sell Short When:
• The price drops below the middle-trough price.
Watch For:
• A price decrease of 10% to 20% from the first peak to the middle trough.
• Two equal highs, not to differ by more than 3% or 4%.
Set Your Target Price:
For the double top pattern, buy (take profit) at a target price of:
• Entry price minus the pattern’s height (distance from the trough to the top of the highest peak).
Triple Bottom Pattern
Triple Bottom Pattern
Three equal troughs amid a series of peaks.
Purchase When:
• The price exceeds the resistance established by the prior peaks.
Watch For:
• A series of three identical troughs at the end of a prolonged downtrend.
Set Your Target Price:
For triple bottom patterns, sell your stock at a target price of:
• Entry price plus the pattern’s height (distance from the resistance to the bottom of the lowest trough).
Triple Top Pattern
Triple Top Pattern
Three equal peaks amid a series of troughs.
Purchase When:
• The price falls below the support that formed from the prior troughs.
Watch For:
• A series of three peaks at relatively the same level.
Set Your Target Price:
For triple top patterns, buy shares at a target price of:
• Entry price minus the pattern’s height (distance from the support to the top of the highest peak).
You Have Just Discovered: The five most profitable chart patterns
- Symmetrical Triangle
- Ascending and Descending Triangle
- Head and Shoulders
- Double Top and Double Bottom
- Triple Top and Bottom
5. Learn How to Minimize Your Losses
No foreign exchange trader likes to admit it, but no chart pattern picking system is perfect. Sometimes, the chart patterns we think will explode, does not materialize. There may not be a foolproof system to predicting currency market movements, but we do have a foolproof system for managing risk. Using these three simple steps, you can reduce the risk in trading in foreign exchange:
Three Ways to Take Risk Out of Trading Foreign Exchange
1. Screen Your Picks. This might seem obvious, but patterns that look like they are developing into predictable trends do not always follow through. Trade only the most clearly defined patterns.
2. Get In. Get Out. We strongly advise that you set a realistic exit price before entering into a position. We recommend that you take profit when prices have reached your expected target, and to cut losses if prices do not move in the expected direction.
3. Set Tight Stop-Losses. This step is absolutely critical in minimizing your risk in currency trading. If a chart pattern fizzles-out, that is when you need to cut your losses and move on to look for a clearer pattern forming in the other currency pairs.
Time to Get Started!
You’re ready. You know everything you need to make big money on currency trading, and you can put all of these tools to work now. Sign up for a Demo Trading Account, and start looking for the right patterns. Then use our easy-to-follow principles of risk management and start trading foreign exchange to ensure you are gaining experience without risk on our trading platform.
Of course, doing this will improve your confidence but will not give you cold hard cash. So why wait. Open a Live Trading Account when you are ready to enjoy a profitable trading career.
Top 5 Reasons Why You Should Use Technical Analysis to Start Trading Now
- Clearly defined strategies reduce fear and indecision.
- You will be able to spot appropriate entry levels, avoiding the impulse to chase the market in fear of missing out on a move.
- You will be able to read the market better.
- You will exit successful trades before your profit evaporates.
- You will know when to let your profits run.
