Trading Guides

Technical Analysis

Technical Analysis concentrates on the simple fact that history repeats itself as well as a graphical representation of the market price action. This type of analysis is ideal for long-term to short-term strategies, depending on the timeframe used during the analysis process. Technical analysis is the examination of past price movements to forecast future price direction. It is sometimes referred to as chartist analysis because it relies almost exclusively on charts for analysis. Technical analysis is applicable to foreign currencies, stocks, indices, commodities, futures or any tradable instrument where the price is influenced by the forces of supply and demand. Price refers to any combination of the open, high, low or close for a given commodity/security over a specific timeframe. The time frame can be based on intraday (tick, 5-minute, 15-minute or hourly), daily, weekly or monthly price data and last a few hours or many years. In addition, some technical analysts include volume and/or open interest figures with their study of price action.

Trends

“Markets are trendy – let the trend be your friend”The first trend theory holds that an uptrend remains intact as long as each successive intermediate is higher than those preceding it and each reaction stops at a higher point than previous reactions. Conversely, a downtrend prevails when each intermediate decline carries price falling short of earlier rallies. When you’ve defined the direction of the market through technical analysis, then follow it! Weekly and monthly charts are useful in giving an idea of how the market has behaved and how it is likely to behave in the future. Once you have selected the nature of the trend you wish to follow, then you can identify the full scope of your trading strategy depending on the timeframe you are comfortable with. In an uptrend market, try to buy the dips to maximize profits. In a downtrend market, try to sell the rallies.

Support & Resistance

Support and resistance levels are unquestionably among the most important of all technical considerations. They are areas which prices are expected to have difficulty moving beyond, and they therefore deserve careful consideration in buying and selling decisions.

Support and resistance levels on a chart can be divided into three basic categories:

  1. Congestion areas.
  2. Areas at which previous advances and declines were turned back.
  3. Transformed support and resistance levels following a break of the support / resistance levels (generally 30 pips) – i.e. once broken, former highs that have been penetrated thereby turn into support levels.

The basic idea behind resistance and support theory is simply that price levels that were significant in the past will have significant impact on price action in the future and should therefore be considered when building a trading plan. Major Support (troughs) The price level or area on the chart where buyer interest is sufficiently strong enough to overcome or digest selling pressure and a price decline is turned back up again.

Major Resistance (peak)

The price level or area over the market where selling pressure overcomes or digests buying pressure and a price advance is turned back.

  1. The longer the trend line has been intact, the more significant the trendline.
  2. The more the number of times the trend line has been tested, the stronger the trendline.

Validity of Trendline Violation

  1. The price filter used is a 1% or 3% penetration criteria to eliminate whipsaws. A closing price penetration beyond the trend line is more significant than just an intra-day penetration.
  2. The time filter requires that prices close beyond the trend line for 2 successive days.

The Pro-I Trading charting package provides users with key technical analysis indicators such as Moving Averages, Bollinger Bands and Volumes.

Fundamental Analysis

Fundamental Analysis focuses mainly on the economic, social and political forces that drive the supply and demand, hence the market price. This type of analysis concentrates on macroeconomic indicators such as economic growth rates, interest rates, monetary policy, inflation and unemployment. The key to fundamental analysis is to gather and interpret this information and act before the information is incorporated into the market price. The lag time between an event and its resulting market response presents a trading opportunity for the fundamentalist. Example Using the currency market as an example, there are times that governments through their Central Banks stand in the way of market forces impacting their currencies. Hence, they intervene to keep currencies from deviating markedly from undesired levels. Currency interventions have a notable and oftentimes temporary impact on FX markets. A central bank could undertake unilateral purchases/sales of its currency against another currency; or engage in concerted intervention in which it collaborates with other central banks for a much more pronounced effect. Alternatively, some countries manage to move their currencies, merely by hinting, or threatening to intervene.

Factors Here are some major fundamental factors that can affect market prices:

  • Decisions on interest rates made by central banks such as the US Federal Reserve or the European Central bank (ECB) monthly.
  • Quarterly GDP figures. Only preliminary national GDP figures generally have the effect of changing market sentiment.
  • Market sentiment data. Market expectations are formed from one week to two days before the event. If the figures are not a surprise for participants placing orders based on such expectations, profit making is usually the result.
  • Political Events. National elections, terrorist attacks and conflicts are events that have affected the markets.
  • Major indices. Inflation indices, Institute of Supply Management (ISM) in the US and the Purchasing Management Index (PMI) in Europe are also carefully followed by traders.
  • National industrial production figures. US non-farm payrolls (indicating new jobs created), Michigan sentiment figures in the US, the German business climate or IFO index, and the Tankan quarterly survey in Japan.

Technical and fundamental analyses are both closely linked but they are independent and complementary. Fundamentals assess general market trends while technical analysis is more refined, providing specific entry and exit points for a trade. It is recommended to use a combination of both when defining your trading plan. Any trading strategy in foreign exchange is based on the following assumptions:

The state of the market First of all you take an overall view of where the market is going.
Timeframe for trades Determine if the position you want to take is long term or short term.
Time your trade properly Don’t jump on the first price available, wait until YOUR price is available.
Gauge sentiment Review technical analysts’ consensus and political conditions.

 

Making a Trade Plan

If you trade foreign exchange, or Contracts for Difference, you need to understand the core components of online trading – technical and fundamental analysis – to trade effectively and to be able to make trading decisions fast and accurately.

  1. Analyze the overall trend of the market.
  2. Consider the macroeconomic indicators associated with fundamental analysis.
  3. Use technical analysis (trend, tools, and support/resistance levels) to define precisely your entry and exit points (limit order and stop loss using OCO).

Trade Your Plan

  1. When a price is available, or close enough to your entry point, then pull the trigger! Another opportunity may not be available later on. When the entry point is in your sights, take it. Wait too long and you may miss it.
  2. Set up your OCO (limit order and stop loss for your trade). By doing so you protect your position whatever happens in the market and remove the stress attached to the trade leaving two options available: either liquidate for your profit or a predefined loss.