Thursday, March 12, 2009

Technical Analysis Intro

Technical Analysis Intro

This lesson will focus on Technical Analysis. This field of knowledge is probably
the largest in the Forex trading world. This lesson will explain what Technical
Analysis is and what it does. I will also give you a basic technical trading
strategy.

There are two main types of analyzing the Forex market. The first type is
technical analysis. Technical analysis is a way of using historical price data in
different ways to predict the future price of a currency pair. Technical analysis
relies on price charts and various technical indicators to make predictions. The
main assumption of Technical Analysis is that the historical price data reveals
patterns that repeat themselves over time.

Fundamental analysis is also a popular way of analyzing the Forex market.
Fundamental analysis examines different facts about the economy to predict
price movements. Lesson #4 will concentrate on fundamental analysis
exclusively.

I am explaining technical analysis first because it is the easiest and most precise
way of trading the Forex market. "The numbers don't lie" is a phrase that applies
more to technical analysis than to the fundamental approach. Technical analysis
can be learned much faster than fundamental analysis and requires less
expertise.

I mentioned above that technical analysis is based on technical indicators. These
indicators make different mathematical calculations and display the results on a
price chart. The skilled Forex trader interprets these indicators and makes
trading decisions. So how do you become a skilled Forex trader, friend? Read
on to find out.

The most basic technical indicator is one that you can draw with your own hand.
I will simply explain this indicator, but you will not use it. This basic indicator was
used early in the stock market, and is still used today. This indicator is known as
a "trend line". To draw a "trend line" you simply:
1. Print out an historical price chart for a given time interval of a currency pair.
2. Draw a line connecting two or more parts of a graph that have higher lows, or
lower highs. Poof! Now you have a trend line. This trend line represents the basic price
direction of the currency pair. When the price of the currency pair breaks through
the trend line in the direction opposite of the trend, you would expect a reversal.

By reversal I mean this:
1. If the prior trend was upward and the price broke through the trend line moving
down, this would indicate a new downward trend using the trend line method.
2. If the prior trend was downward and the price broke through the trend line
moving up, this would indicate a new upward trend using the trend line method.
Trend lines can act as either floors or ceilings for the price data. When these lines
are penetrated, the price usually moves completely to the other side of the trend
line.

Suppose you are monitoring the EUR/USD (a popular currency pair). You draw a
trend line connecting 3 points where higher lows are reached than previously on
the chart. After you draw the line, you notice that all of the price data on the chart
so far falls below the trend line you have drawn. The trend line is acting like a
"floor". The floor appears to be a boundary that the price will not cross. So now
you wait until the price crosses the boundary. A few periods later you notice that
the trend line has been broken when the EUR/USD fell below it. So now you
would expect the price to go even lower because the "trend line" method
suggests that an old floor will act as a new ceiling. So now you can expect all of
the prices to be below the trend line once it has been broken.

Once the trend line is broken, the prices should stay below the trend line. This
method is not very scientific. A lot of the method depends on how you draw your
trend line. I have also given you a simplistic version of the trend line method.
There is a little more to it.
Because the trend line method is not very scientific (or accurate) better methods
have been developed. Some changes were made to the trend line philosophy
and many people called for a more precise method. There are actually many
more precise methods available today. The next method was not a practical
candidate to replace trend lines until the computers reached the sophistication of
the mid 1990's.

The Simple Moving Average (SMA) is a theoretical extension of the trend line
concept. The Simple Moving Average is plotted on a graph by the charting
program for the Forex market data. The SMA takes the average of the close
price of a given number of the last few periods. Any number of periods can be
selected. You can have an SMA5 or an SMA20. An SMA5 will take an average
of the previous 5 close prices on the chart and will plot it on the chart alongside
the other price data. Each bar will use the previous 5 bars worth of data to
calculate a point and plot it on the graph.
If the SMA is generated using a large number of periods (like an SMA50 or
SMA75), you could interpret it similarly to the trend line. But if you select "faster"
SMA's (like an SMA5 or SMA20), you need to use a different strategy.
I am about to give you a strategy using the SMA. In lesson #5, I will tell you how to set up a free demo account and begin using this strategy for practice trades.

This strategy is a very basic one. It does not have a high degree of accuracy, but
it is very easy to do and it is fun. It is a good technique to begin trading with. I
want you to keep in mind that there are better strategies out there.

The SMA crossover method. After you have set up your free demo account
(lesson #5), you need to open the charting software. The SMA is one of the most
commonly used indicators and can be found in almost every charting package out
there. When you plot the SMA, you will be able to select a line color to plot it.
Make sure to use a different color than the actual prices on the chart.
Step 1: Plot an EMA5 using blue (or any color you like)
Step 2: Plot an EMA20 using red (or any color that is different than step 1's color)
You now have 2 SMA's plotted on the chart. You also have two signals.
Buy signal: When the SMA5 crosses the SMA20 moving up ward.
Sell signal: When the SMA5 crosses the SMA20 moving down ward.
The beauty of this method is that the price of the currency pair can not go up
significantly without triggering the buy signal. In other words - if the currency pair
begins to trend up, then the buy signal must be triggered. The opposite is also
true - if the currency pair begins to trend down, then the sell signal must be
triggered. The only time where this system fails is when there are false alarms.
Sometimes the currency will act like it is going to trend up and then it will trend
back down.

Here is a way to see how the SMA's predict price movements. You should open
up some charts and put on the SMA5 and SMA20 overlays. You can then look at
the times where the price fell/rose significantly. What did the SMA look like near
the beginning of the price movement? What did it look like after? By viewing
how the SMA reacted in the past you will get an intuitive feeling for how it will act
in the future after an SMA crossover.

The SMA crossover method will work best in longer time frames. If you attempt
to use it for tick-by-tick day trading, it will probably only produce losses. This
method works better for trades that last weeks, or months. I have only shown
you this method so you can trade it for fun. I strictly want to caution you not to
trade any real money using this system ever, unless you add tips from the
Forexezine to it and perfect it for yourself.

Insider Secrets of Online Currency Trading will provide you with other
techniques in the future. This is an easy one to get started with. I have also
personally developed 2 trading strategies that utilize more powerful techniques.
In the next lesson I will let you know what fundamental Technical Analysis is and some of
the basic measures it considers. The 5th lesson gives you what you need to
understand and open a demo account.

1 comment:

  1. I would advise that you pick the most recommended Forex broker - eToro.

    ReplyDelete