|Evaluating Technical Analysis|
Technical indicators help make specific entry and exit decisions. Regardless of the indicator used, you must understand how it works and have the confidence to follow the signals. The indicators used are based on historical data and show up either on or below the price chart. Although these indicators are helpful in understanding when to buy and sell, they are not perfect in getting you in and out every time. Use them to develop your trading system and they will help you become a successful currency trader.
Here is the order of importance for evaluating charts:
By following this order of importance you will be able to properly evaluate charts and know when to best enter and exit your trades.
It is always important to remember the phrase, "The Trend is Your Friend".
A downtrend is defined as a period when price moves in a series of lower highs and lower lows. An uptrend is defined as a period when price moves in a series of higher highs and higher lows. In the chart above, you can see the price of this currency pair has been making lower highs and lower lows. This would indicate that the pair is in a downtrend. As long as the trend continues to make these moves, you will want to anticipate a continuation of this trend. When you begin to see this pattern being broken, you will look for a reversal of the trend.
Support and Resistance:
The idea of support and resistance is one of the most critical concepts you will learn. These are areas where traders have psychologically placed price targets, both high and low. The price will tend to bounce up or down off of support or resistance levels. Support is like the floor, and once hit, it will tend to bounce upward. Resistance is like the ceiling and once hit, will tend to bounce downward. You need to be able to identify areas of both support and resistance, so you can know where the price is likely to go. Remember, this is an area of support or resistance, not an exact price.
Support is the price area where the currency pair will stop its downward movement. This is an area where you will look to buy the pair as it bounces up off of the support floor. This support can be either price support (horizontal) or trending support (diagonal). The more the area of support is tested, the stronger the area becomes. Many traders look for these areas and place buy orders to enter at the support, which makes these support areas even stronger.
Resistance is the price area where the currency pair will stop its upward movement. This is an area where you will want to look to sell the pair as it bounces down off of the resistance ceiling. This resistance can be either price resistance (horizontal) or a trending resistance (diagonal). The more the area of resistance is tested, the stronger the area becomes. Many traders look for these areas and will place sell orders to enter at the resistance which makes these resistance areas even stronger.
The first technical indicator that an investor needs to understand is the Moving Average (MA). MAs are the most common type oftrending indicator and will help you to identify entry and exit signals. One of the most important things the MA will do is help you identify the trend of the currency pair. If you are using a short-term MA, you will know if you are in a short-term uptrend or downtrend, based on the direction of the MA. If the MA is moving up, the currency pair is in an uptrend. If the MA is moving down, the currency pair is in a downtrend. The longer the MA period, the stronger the trend will be. In addition to helping determine the trend, the MA will be a good indicator of support and resistance. Because MAs use historical data, they lag the market and only show the changes after the prices have changed. There are multiple types of moving averages that can be used. Simple, exponential, and weighted are the most common. A simple moving average (SMA) is the most common and is derived by taking the closing price of the last number of time periods and adding them together, then dividing by the number chosen.
The Stochastic indicator was created by George C. Lane and was designed to help project future price movement. This is primarily an indicator to be use in a non-trending currency pair, to project a potential change in direction or momentum. This oscillating indicator moves between a low of 0 and a high of 100. The area below 20 is considered oversold and the area above 80 overbought.
There are two primary signals that come from using the stochastic indicator. First, when the Stochastic lines move below 20 or above 80 and then reverses and comes out of the areas. Second, when the two stochastic lines (k and d) cross each other, regardless of where they are located on the chart.
When the stochastic indicator moves below the 20 line on the graph and then turns and rises above the 20 line, this is a bullish signal. When the stochastic indicator moves above the 80 line on the graph and then turns and falls below the 80 line, this is a bearish signal. This is a more conservative signal, because you are waiting for confirmation. The price of the currency will be moving in the direction you are looking to trade before you get into the position. As long as you trade with the trend, this will often be a good entry signal. The downside to this signal is it will be delayed and you will get in after the currency pair has already begun to move.
This signal occurs sooner and more often than the first signal. This is a more aggressive trade and often times gives false signals or whipsaws. The difference is you don?t wait for it to move above the 80/20 line, you take the signal as soon as the K line and D line cross. This could be anywhere on the graph regardless of whether or not it is above or below the 80/20 line. When the faster K line crosses above the slower D line, it is a bullish signal. When the faster K line crosses below the slower D line, it is a bearish signal. Furthermore, you will only take a position when trading with the trend of the currency.