Technical analysis is not an exclusive thing for the currency market. Traditionally, stock market analyst used technical reasoning to better understand the market condition. However, because foreign exchange market is the most efficient and competitive market, it is often the bread and butter of the currency traders.
The following tips will help you understand a technical chart:
1. Understand Charts
In all forms of technical analysis you will encounter something called a chart. A chart will include two axes (x-y), where X will represent time and Y will represent price. The whole idea is that if you can judge the previous price data which is represented on the left of X axis, then you will be able to forecast where price will move next in time on the right of X axis, up or down. And of course, there is all the fun!
There are perhaps a million technical indicators out there on the internet to do this simple thing by analyzing the same time and price data from million different angles. However, once you finish reading this post, you will be in a better position to read technical analysis.
2. Understand time-frames
At first glance, reading a chart seems to easy right? Yet, one might wonder why there is a whole industry of experts trying to interpret the same charts so differently. Well, first of all because people have different expectations and we are all operating on different timeframes. A TV analyst may be commenting on the price movement of EURUSD for next several months. The forum “Guru” on the other hand, may be only predicting for next day or two!
Your chart reading or interpretation will vastly depend on which timeframe you are analyzing the time and price data. So make sure you use multiple timeframes to judge the market condition and not fall for the newbie trap of going into 5 minute chart; then trying to predict where the price will move to by the time you will send you kids to college!
Trend is a general bias towards the movement of the price over a period of time. Remember all those million technical indicators? They are all trying to find the Trend. Trends are basically the pivotal movement of price over time in a certain direction in a certain timeframe. So there could be multiple trends going on in a single currency pair. A daily chart may show a long (buy) trend and one hour chart may show a short (sell) trend. Thus, it is important to understand which timeframe you are going to find trend. Before you move on, trying to interpret a chart and do some technical analysis, make sure you understand reading the trends. Because as old it might be, the golden advice is still: follow the trend because trend is your friend.
4. Understand market condition
There are basically three market conditions. Bull market, as you may know is the when price has been trending up. On the other hand, Bear market happens when price has been trending down. Both of course on a given time frame, as we discussed. However, more than often you will find that price is neither going up or down. Most traders lose money in this kind of ranging market. The street name for this is the lamb market.
Unless you understand the different types of market condition, you will always end up trading against the trend of become the last member of the zoo, a hog. As they say bears make money, bulls make money and hogs get slaughtered. So understand market condition, don’t go against the trend and in a lamb market; don’t try to buy at the top thinking it is a trend!
5. Understand indicators
Before I say anything, let me apologize in advance. There is not a single indicator that can predict the market price more than you and I can without the indicator. Even best forex brokers and stock traders consider not only a single indicator but a lot to ensure accuracy. As I mentioned, indicators read historical data then try to provide a visual representation. Hence the candle stick itself can be called as an indicator if you get my drift.
There are different sets of technical indicators that suit different market condition. For example, using moving average in a range bound market will be a total waste of time. As moving averages works best in trending markets. On the other hand, using oscillators such as stochastic or MACD to find divergence in a trending market is a sure fire way of getting a margin call, if you are trading against the trend.
Once you get to understand the basic topics of technical analysis mentioned in this article, you will find that all eye candies we see on a technical chart basically has no real world use. To become a successful reading a chart you need to understand market structure first. Once you know how to figure out the market structure from looking at a chart then it will be easy to make decisions based on what you see, and not on what you think!