Technical Analysis in Forex Trading
Technical analysis is a set of methods applied to predict future changes in the prices of financial assets, through analyzing their historical price movements and patterns. The foreign exchange market is particularly favorable for using technical analysis as its high liquidity in trading volumes and participants, and vulnerability to large scale long-term national trends, often result in trends that occur over time and patterns that are able to fully emerge. In addition, technical analysis can also be effectively used to construct and implement short-term trading strategies in forex markets.
Forex Chart Patterns
Forex traders can employ a variety of technical analysis techniques that are commonly used in other markets, such as various chart patterns, like wedges, triangles, channels, double tops and bottoms and head and shoulders. Additionally, quantitative and blended techniques including moving averages, Bollinger Bands, and Fibonacci retracements are widely adopted. Analysis of oscillators and indicators of momentum, for instance, MACD, RSI, and stochastics are also commonly used. Popular techniques like Wedge patterns and Bollinger Bands are two examples of the extensively used technical analysis methods in forex markets.
Wedge patterns
Wedge patterns usually suggest that a change in trend may be about to occur, thus, if the price is displaying a downward trend within the wedge, it is expected that the trend may shift to an upward trend once the price surpasses the top of the pattern. Wedge patterns can be either bullish or bearish, based on the present trend displayed within the wedge, and they tend to be longer term patterns (three to six months).
Bollinger Bands
Bollinger Bands are a chart overlay that displays a line two standard deviations above a simple moving average and a line two standard deviations below it. This is a widely adopted technical analysis tool as it offers a good assessment of volatility. As the price of the chart approaches the upper band, it can be considered as increasingly “overbought” , and when it approaches the lower band, it is more likely to be “oversold.”
Forex traders can apply these techniques on charts with any time frame, from tick or minute charts, all the way to weekly or monthly charts. In addition to identifying trends, technical traders also use these techniques to determine price objectives, stop-loss levels, and trade entry points, frequently looking for a risk-reward ratio of at least 2:1.
Forex candlestick patterns
Forex traders can also employ eastern technical analysis methods like candlestick patterns, particularly for short-term trading and pinpointing critical junctures. Some of the frequently used candle patterns in forex analysis are dojis, hammers, hanging man, morning and evening stars, and engulfing candles.
Many forex traders find it beneficial to combine multiple analysis techniques, as the greater the number of indicators that indicate a potential trade, the higher the level of certainty.
Reverse charting
A technical analysis tool that is particularly useful and readily available to forex traders, but not as easily accessible for traders of other types of assets.
One common technical analysis principle is “when uncertain, flip the chart upside down”. This was straightforward with paper charts but became less so with the advent of digital charting, although it has become somewhat easier for traders using mobile or tablet apps.
In the forex market, which operates on pair trading, it is easy to invert a chart by reversing the base currency of the pair being charted. One interesting pair to examine in this way is USD/CAD, as both versions of the chart are widely used by traders. USD/CAD is the global convention used by traders around the world. CAD/USD, on the other hand, is frequently referenced by the Canadian media and public, so key levels on either chart can impact analysis and trading and become potential turning points, like USD/CAD $1.2500 and CAD/USD $0.7500, for instance.
It is also worth noting how Wedge patterns and RSI divergences complement each other in this type of chart.
