Technical Analysis – From Beginner to Expert

Technical Analysis – From Beginner to Expert

Technical analysis is one form of analysis that traders use to define the strategies they will implement

in their trading experience. The purpose of this type of analysis is to evaluate currency movements by

observing and analyzing data from previous market trends and behaviors. Technical analysts are

always on the lookout for patterns that will help predict price fluctuations and movements within the

current state of the market.

What are some of the foundations that technical analysis is built on?

1. History repeats itself. Technical analysis stands on the premise that previous trend

patterns will repeat themselves.

2. The best way to identify trends is to analyze price movement and the supply or demand

of currencies.

3. Price movements follow a trend. Once a trend is established, the relevant currency will

follow that trend until it shifts.

Within technical analysis, traders make use of several different techniques including support and

resistance, moving averages, Bollinger bands and trends. In this chapter, we will look at the first

three which is believed to be the most popular among forex traders. The idea is to expand on

technical analysis at a deeper level while adding tools to your trader’s toolbars (particularly if you

are a beginner trader).

Support and Resistance

Support and resistance is a common yet highly effective tool in your technical analysis. Most forex

traders and other types of traders implement this tool in their trading including the traders at Wall

Street.

Support acts as a floor to the prices of the currencies you are trading; its job is to slow down prices

from dropping beyond a certain point and hopefully turn the trend back up. Resistance on the other

hand is a price ceiling often preventing prices from continuing upward.

Support is affected when a large demand of currencies occurs. This prevents the price from dropping

further while pushing it into an upward trend. Resistance works in the opposite. When there is a large

supply for currencies the price will bottleneck at the resistance level preventing it from breaking

through.

Below is an example of what support and resistance will look like on your technical analysis charts:

Now that we’ve established the definitions of support and resistance, let’s have a look at three

common ways of identifying support and resistance.

1. Intermediate reversals. Here you look at your charts for past trends and identify those

points where the trends turned (up or down). You then play dot-to-dot by drawing a line

across those common points (top and bottom). The line that you draw shows you where the

estimated support and resistance lies.

2. Round numbers. Psychologically people are drawn to round numbers. When traders see

round numbers they will either assume the price has gotten too expensive and sell or they

will assume the price is cheap and buy. This in turn changes the current trend in the market

and sets a support and resistance level.

3. Moving averages. Moving averages are a good indicator of current trends and levels of

support and resistance. They show the average actions traders have made with certain

currency pairs.

While support and resistance can give you an indicator of when to buy or sell your currencies and

where to place your stop loss order, they are not absolute predictions. Always use them as a guide.

Use them to confirm your other analysis findings or vice versa.

Moving averages

In lay man’s terms, moving averages is the average currency price extended over a certain period of

time such as a few days, weeks, or months. The goal of the moving average is to assist traders in

identifying trends and when to open a trading position.

The challenge with moving averages lies in their lagging nature. This means that they only confirm a

trend once it has already happened. Identifying new trends cannot be done with moving averages

whose job is to confirm a trend not establish one.

This leads to an important point regarding moving averages. Moving averages work best with a

shorter time frame. In a longer time frame moving averages experience a reduction in sensitivity and

accuracy.

Let’s have a look at the two types of moving averages:

1. Simple moving average (SMA). When implementing SMA, you would specify the time

period you want to analyze and you would receive an average for each time frame. SMA

gives equal weight to the periods specified. The main problem with SMA is that it is highly

susceptible to anomalies. Thus if a currency pair is on an uptrend and a news release is made

plunging that currency pair into a negative spiral, your SMA statistics are going to reflect it

instead of registering it as an anomaly.

2. Exponential moving average (EMA). With an EMA, you will specify your time frames

as per usual. The difference comes in the weight on the prices. EMA will provide more

weight to current prices while giving lower weight to the prices that started the analysis.

Thus if an anomaly occurs it will not throw off your averages.

While you can choose one type of moving average over the other, I do suggest using both at the same

time but with different time frames.

One of the most popular ways of reading moving averages is to implement the crossover trading

strategy. The price of your currencies will move from one side to the other ending in the close. This

helps the trader determine their exit and entry points.

When a crossover crosses below a moving average, the trader knows that a downtrend is occurring

and they should close their trade. If a crossover crosses above a moving average, the trader knowns

that an uptrend has started. This is a good time to open a trade and cash in those profits.

Bollinger bands

Let’s have a quick look at Bollinger bands and how to use them in your forex trading. Bollinger bands

were named after John Bollinger. Their objective is to illustrate the volatility of the market. Is the

market loud or quiet? Highly volatile or stable? The answer to these questions depend on what is

happening in the market.

Bollinger bands are a more illustrative form of support and resistance. Generally speaking, the market

norm is between the two bands, namely the middle. What goes up must come down.

How do you use Bollinger bands?

1. Bollinger squeeze. The Bollinger squeeze helps you identify a breakout. If the bands

narrow together at the top, a breakout is about to happen and the price will continue upward.

The same can be said if the squeeze happens in the opposite direction.

2. Bollinger bounce (What I like to call the Bollinger funnel). When the bands are narrow,

the market is quiet, experiencing very little action or movement. When the bands are further

apart, the market is considered to be loud with a lot of traders buying and/or selling.

Below is an example of a Bollinger band.

As you can see the white bar charts reflect the price and trade movement of the forex market. The blue

lines represent the Bollinger band. In this particular example, the market is quite loud although it

quietens down towards the right side of the chart.