By Kathleen Brooks: Research Director UK, FOREX.com
The forex market can be overwhelming for a novice trader. Some people think you have to be glued to the computer screen constantly watching prices, always ready to react if prices move in the direction you want.
But what about those who can't sit in front of a screen for that long? What about those people who work or need to organize their kids/ dogs/ parents etc. Not many people can sit still for hours looking at prices or charts without losing concentration. But looking at prices is only one aspect of forex trading.
Others think you need to be aware of every piece of news, economic data and central bank speech. Yet in reality no one can be on top of everything all the time. While it is definitely important to have some knowledge about economic data releases and major political events that could move markets, each trader needs to choose their own key metrics that work for them.
Technical Analysis Basics for Forex Traders
Technical analysis is a great tool to add to your forex trading kit. This may not be the Holy Grail, but it is useful to determine trend and direction, as well as overbought and oversold conditions in the markets.
My two favorite technical indicators are listed below and they include a brief explanation of each one and what it can be used for. I consider myself a bit of a fundo-technical trader. This means that I keep up to date with economic news and events, since these are the main drivers of prices, but I use technical analysis when I go to choose and then execute a trade.
Here are two indicators I couldn't be without:
These are the basic indicators you should get yourself acquainted with from the beginning. They make up the base of most other technical indicators and so a rudimentary knowledge early on will help you determine how other indicators work.
Two things are necessary to determine a moving average: firstly a set of prices and a time series over which you want to analyze the data. I look at simple moving averages, which is the mean of the previous prices from the time series you have requested. You can have both short and longer-term moving averages, for example 21 and 200 periods, you can also determine if you want to look at hourly, daily or weekly prices. For example, a 21-hour moving average looks at hourly prices over the last 21 periods, a 200-hr looks at hourly prices over the last 200-periods.
It is worth looking at moving averages alongside a bar or candlestick chart. These charts can sometimes be difficult to read – prices may have fluctuated widely and it can be difficult to spot an immediate trend. Moving averages can help solve this problem as they smooth out prices and help you to determine overall direction in the market. I use 21, 55, 100 and 200 periods for my moving averages as they seem to be among the most widely used in the market. Typically when the short-term average crosses above the longer-term it indicates and upward trend, and a downward trend when the short-term crosses below the long-term.
Moving averages can also be used as support and resistance levels. An important caveat to note is that moving averages are not completely accurate. They are merely indicators of market direction and so should be used with caution.
The Pivot Points
This is another average, but this time of significant prices, for example the high, the low and the close, from the prior trading period. It is a useful predictor of market movement in the short-term. For example, if the market is trading above the pivot point this is taken as a bullish signal, and below the pivot point is considered bearish.
The definition of pivot is something that rotates or swings, or a central or crucial factor. Both of these terms are useful for describing how pivot points work in financial markets. They are often considered turning points for price direction and crucially for traders they are considered leading indicators.
Using the Tools
So how do you use them? Let's use an example. EUR/USD's pivot point is at 1.4375. The pair is quite directionless so we can assume that it should trade around this point, at least in the short-term. However, within a few hours the pair is trading at 1.4390, above the pivot point. This suggests that the euro has some upward momentum behind it. At this stage you need to look at the primary resistance level, which is 1.4425 – the level at which EUR/USD may lose some steam. If it can overcome this hurdle then it may not lose steam until 1.4490 – the secondary pivot point. These pivot points and resistance levels must be determined prior to execution of the strategy.
Pivot points have so many uses they are a must when I go to make a trade, especially when I am looking for stop-loss levels and profit targets. Markets never go up in a straight line, which can be the undoing of many a good day trader. Pivot points help you to determine when an up or down move might have run out of steam and you should think about getting out of a position. It's important to note that pivot points aren't always correct, but they can be a useful tool to have especially if you are a time-strapped day trader.
Technical indicators have been extremely useful. For example, if Europe is having a debt crisis; the euro should be lower right? Not necessarily, it can hold up well against the dollar and the pound but can be sold-off to record lows against the Swiss franc. Technical indicators can help you to grasp what is going on in the markets, hopefully saving you from getting burnt.
There are hundreds of technical indicators; these are just as couple of my favorites. They are not always perfect and don't guarantee you anything, but they help me to get a grip on markets when the news appears contradictory at best and utterly overwhelming at worst. For more information on technical analysis please visit FOREX.com today.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.
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