Technical analysis. How to read foreign exchange market correctly

Technical analisis of the Forex market

25-11-2020

We often mention that about 80% of profitable trading depends on the mindset. So, does it really make sense to waste time studying something that constitutes, figuratively speaking, the fifth part of success?

Technical market analysis, development of a strategy and trading plan are the key pillars without which even perfect self-discipline won’t work since you wouldn’t have a clear understanding what to trade and how.

So, success in the market depends both on technical aspects and psychology. Today, we are going to examine the technical side of trading, how to analyze the market and what to pay attention to. In addition, we are going to touch upon psychology.

So, without further ado, let’s get started. The markets are waiting for us.

Contents:

1. Understanding Technical Analysis of the Forex Market is a Backbone of Profitable Trading
2. Specific Features of the Technical Analysis of the Forex Market
3. Visual Clarity and Informativeness Offered by Candlestick Analysis
4. Wave Forex Analysis
5. Cluster Analysis: Volumes Demonstrating Players’ Activity
6. Uncertainty of the Forex Market and Its Impact on Trading Strategy’s Efficiency
7. Risks When Trading Forex
8. Trading Psychology and Its Role When Picking Trading Strategy

Understanding Technical Analysis of the Forex Market is a Backbone of Profitable Trading

Successful stock exchange trading, regardless of the instrument you trade, depends on the ability to predict the market environment based on the relevant assessment of the current situation.

Forex market analysis is not a task for the faint-hearted since there are loads of factors affecting the prices.

To predict the market situation accurately, the traders use:

  • Fundamental analysis which includes assessment of political, social and economic factors;
  • Technical analysis (TA) based on thorough examination of charts displaying the change in prices.

These types of analysis can be considered separately but at the same time by combining them you can create a bullet-proof trading strategy. In essence, the price chart reflects the impact of fundamental factors on the market.

Big players evaluate the prospects of their investment from the fundamental standpoint.

Their assessment allows predicting global trends (bearish, bullish or sideways) and their possible changes in the short run in response to fundamental factors.

This is particularly important for traders who prefer long-term trading style. The technical analysis aims to predict local trends of the price movements and to “push” the price into the boundaries of graphic figures i.e. patterns.

Specific Features of the Technical Analysis of the Forex Market

Forex technical analysis is based on three key principles:

  • Almost everything that affects the price movements is shown in the chart. This is because the actions of the market players (even those that accumulate positions right before the news release) can be presented in the form of graphic figures, price patterns, and channels.
  • The current trend defines the price movement.
  • Market situations repeat themselves periodically which allows predicting current price movement by examining the price history.

By checking out the charts of indices, you can determine the state of economy and predict the subsequent behavior of a certain currency.

As far as currency pairs go, the uptrend of, say, GBP/USD may indicate that sterling is becoming more attractive for traders and/or that the US dollar is getting weaker.

The trend line angle may give a clue regarding the dynamics of the processes, while the volatility can mean that market players are trading actively.

With that in mind, technical analysts can decide whether or not to enter a long position. It can be risky unless you use forex fundamental analysis at least in the form of data obtained from the economic calendar.

The news release often generates an impulse movement which is impossible to predict based on TA alone.

The second principle answers the question: “How to predict forex market situation?” The current trend defines the price movement.

Visual trend assessment

Depending on the trading style, the traders rely on local or global price trends since the majority of trading systems are based on a principle of opening trades in direction of the trend. That said, there are also counter-trend strategies.

Visual Clarity and Informativeness Offered by Candlestick Analysis

Price charts in the trading platform may be shown as angled lines, bars or candlesticks that many traders prefer.

When analyzing the history data of the prices, you may notice consistent combinations of the candlesticks forming graphic figures. They point to a trend reversal or a breakout of the price level.

Candlestick forex analysis allows estimating the degree of buyers and sellers’ activity during a certain time period.

Forex candlestick analysis

Depending on the trend direction, the candlestick size demonstrates the power of bulls or bears, which, in turn, provides an idea of a dominating trend.

Doji candlestick that has the same opening and closing price indicates the uncertainty of the market situation.

Long shadow of the candlestick suggests the change in the power balance of buyers and sellers. The candlestick is highly informative which helps promptly analyze the situation and decide whether to enter or close positions.

Wave Forex Analysis

Regardless of the trend, the price chart doesn’t move in straight lines but forms a wave which is followed by another one, etc. This is explained by a cyclical nature of human thought.

Based on this, mathematician Ralph Nelson Elliott developed his wave analysis. According to his theory, the price forms five waves in direction of the dominating trend followed by three waves in the opposite direction (a corrective phase).

Forex wave analysis

This pattern manifests itself differently on various timeframes. So, when identifying entry points, it is risky to rely on this theory alone.

Everyone personally decides how to do forex market analysis; however, experienced traders always combine different TA approaches which increases the chances of making winning trades.

Cluster Analysis: Volumes Demonstrating Players’ Activity

The currency market is fast-paced and pretty unstable. The efficiency of certain approaches to price trend prediction decreases and that forces analysts to look for new patterns.

Back in 2004, another technical analysis tool became available to traders. It is the information on accumulation of volumes which form price levels.

This data allowed factoring in real volumes of trades made at the moment and those traded in the past.

Forex cluster analysis

With this in mind, special software was created to help keep track of the formation of trading volumes inside the bars and assess the players' current activity in certain areas.

Cluster analysis (new approach) allowed making an unbiased assessment of the market situation. Since all other TAs are based on market price, their efficiency is roughly the same.

They always refer to the current moment, whereas volumes help make predictions of high certainty regarding the future price movement and strong key points where volume was accumulated.

Horizontal bar chart (Market Profile) is a powerful tool designed for analysis of the market situation and its unfolding scenarios. It is a go-to trading indicator which helps big players understand the strength of the levels.

Horizontal bar chart is the Market Profile

Market Profile displays traded volume, as well as helps determine asset accumulation levels and areas where the trend starts and where it gets weaker.

The estimation of volumes is done using special variations of market profile display, allowing to determine accumulations in the chart segments.

In addition, these areas can be identified with help of clusters i.e. price bars broken down into levels. They reflect the trades volume at a point the bar passes through.

Cluster analysis tools made it possible to create new profitable forex trading strategies.

Uncertainty of the Forex Market and Its Impact on Trading Strategy’s Efficiency

When it comes to trading currency pairs, it is important to note that it has a number of features. The forex market is ever-changing and therefore you should always be on a lookout for new patterns and analytical tools.

The better you understand the processes occurring in the stock exchange, the higher the odds of making solid profits. This is why trading implies continuous training and search for new trading techniques.

Each of the existing analytical tools is perfected by professionals and thus has a ton of nuances that you need to be aware of.

Understanding them helps create successful trading strategies but it’s important to remember that they cannot produce profits all the time.

The exchange market is open 24 hours a day. Trading zones of the East are most active at the beginning of the day. When Europe tunes in, the market activity spikes. And when the East falls asleep, the United States takes over.

The accessibility makes this market hard to predict. Only by knowing the ins and outs of the stock exchange operation can you make money with forex.


Risks When Trading Forex

The average daily turnover in the forex exchange is over 5 trillion U.S. dollars. This is an astronomical amount of money. Many people are looking for ways to make money with forex. It is possible but there is still a high risk of losing what you’ve invested.

This is explained by:

  • Presence of the dealing centers which practice internal clearing.
  • Lack of knowledge and experience.
  • Faulty trading system.
  • Inability to manage money, and a number of other reasons.

Due to the nature of the forex market, you won’t be able to make consistent profits unless you have a comprehensive approach to trading.

The temporary success of the novice traders typically remains temporary. Only by being aware of the risks and knowing how to manage them can you actually succeed.

Trading Psychology and Its Role When Picking Trading Strategy

When it comes to trading, the importance of a stable mental state is often mentioned in various trading-related books and cannot be emphasized enough. However, that doesn’t necessarily mean that professional traders have nerves of steel.

Not many people are able to keep their composure when trading forex. This is why trading psychology is considered one of the key aspects of investment psychology.

This science aims to explain market behavior on the basis of the investors’ personality traits. Most of them often make spontaneous and illogical decisions.

Trading psychology when making trades

Technical and fundamental analysis are based on objective indicators that do not factor in irrational behavior of the traders, whereas forex trading psychology is mostly determined by this factor.

Every person intuitively wishes to lessen psychological pressure that causes discomfort.

As far as trading goes, this is achieved through a sensible approach to choosing a trading style that matches the trader’s personality traits:

  • Scalping is suitable for impatient people who wish to achieve goals fast. Scalpers are able to assess the situation quickly and make the best decision in the given scenario.
  • Day and swing trading will work for disciplined and cool-headed traders with extensive knowledge of fundamental and technical analysis.
  • Position or long-term trading is perfectly suited for patient traders that are not prone to making impulsive decisions.

The experience has proven that the best forex trading strategy is the one that generates consistent profits without putting additional stress on the trader.

Only by remaining calm can the traders observe the main principle of the forex trading which is to buy the asset at a cheaper price and sell at a higher.


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