Top Forex Technical Analysis Tools To Learn
One of the most common pieces of advice given to beginner forex traders is to learn some technical analysis skills. This can seem like a slightly scary prospect if you are not naturally great with graphs and charts, but it’s actually more important to understand the concept behind the ideas than to grasp all of the fine detail.
This is because even the expert analysts make wrong decisions sometimes, and no two technical analysis traders will interpret data in the same way. As long as you are aware of the major tools and have some idea of how to use them, you will then have the freedom to decide which ones to learn about in more depth to help your trading.
So what is technical analysis?
Technical analysis is the study of price movements in the market, to help traders predict future trends, and therefore make the most profitable trading decisions based on their knowledge. Analysts study historic chart patterns and indicators of price action to inform their approach.
This is based on the theory that the rhythm and flow of price action tends to repeat itself. So, by studying how prices performed in the past, it is possible to predict future movements, on the basis of probability. The easiest way to examine and interpret the data is through charts, because they allow you to see the patterns in a visual way.
So, all technical analysis involves reading charts based on historical data. Indicators can then be applied to these charts, to identify the most profitable entry and exit points into the market for forex traders. It allows you to spot the best trading opportunities, and make the most of your forex funding.
Some traders make their decisions based solely on using technical data to read the probabilities of future price movements. Other traders rely solely on the economic data releases and wider macroeconomic events to make their predictions and decisions, which is known as fundamental analysis.
There is no right or wrong way of applying analysis tools; in fact, many traders combine several methods.
What are the benefits of using technical analysis?
Technical analysis can be used to provide the most probable entry and exit in the market for a profitable trade. They also offer a good form of risk management, because they give you some insight into how the market is trending at a particular time or price point, thus reducing the amount of loss-making decisions that you make.
Once a trader has grasped the concept of technical analysis, the tools and techniques can be applied to a wide range of markets to identify trends. The majority of traders now use at least one form of technical analysis to help them identify the best potential trading setups.
What different types of charts are there?
So, forex technical analysis is all about the charts. They are simply the best method of visual representation of price movements over a set period of time. It probably won’t surprise you to learn that there are several different types of chart which are the tools of the trade. Here’s a look at some of the most popular price charts.
Line charts show a currency pair’s movement over a set period of trading time. This could be months, weeks, days, hours, or even minutes. The construction of the chart is much like any other that you would use to see visually represented data over time: the horizontal x-axis represents the time scale, and the vertical y-axis represents the price scale.
The lines on the chart plot the difference between the closing price of a currency pair from one trading session to the next. It does not show the fluctuations of price within the trading period, just the overall closing trend, whether upwards, downwards, or no change.
Some traders prefer to use just the closing trend, which they consider more relevant to their decisions than opening prices or fluctuations within a trading period. Line charts allow the viewer to take in the big picture, which is useful for long-term trading strategies, over weeks or even months.
If you are a complete beginner getting to grips with technical analysis tools for the first time, then line charts are an excellent introduction. They allow for an easily digestible overview of the market, without the extra complications of a high volume of data within each movement.
Once you have got comfortable with line charts, then the next step is to get to grips with bar charts. These provide a greater level of detail than line charts. They show the high, low, open and closing prices (sometimes abbreviated to HLOC charts). This means that they can visually represent volatility within the markets, in a way which line charts cannot.
The chart displays vertical lines which represent the highest and lowest price points in a single trading period or segment of time, with the opening price indicated by a dash to the left, and the closing price indicated by a dash to the right. A bar that has closed up is represented in green, and a bar that has closed down is represented in red.
The vertical height of the bar is dictated by how much variation there is between the opening and closing price of a currency pair. This provides a good way to view the volatility in the markets, as well as giving an overall picture of whether the market is bullish (on the rise) or bearish (declining).
The candlestick chart is similar to a bar chart, but it has a slightly different format. Technical traders often prefer them to bar charts, because they are easy to read at a glance. Like the bar chart, they display the HLOC prices for each specified trading period. However, the data is displayed in a slightly different visual way.
The vertical is represented as a block, or the ‘body’ of the candlestick. This indicates the range between the opening and closing prices. The block is filled or coloured in if the closing price was lower than the opening price. The block is left unfilled if the closing price is higher than the opening price.
Some charts will use black and white colouring, whilst others may use red and green, or other colour combinations. This allows the viewer to see from one glance whether a currency pair has closed up or down, and if the overall market trends are bullish or bearish.
A black or red candle indicates a seller’s market, because the closing price was lower than the opening price, while a white or green candle indicates a buyer’s market, because the closing price was higher than the opening price for that particular currency pair.
More detail can then be ascertained by studying the candle ‘wicks’, or upper and lower shadows, which are vertical lines above and below the main body. These show the highest and lowest prices for each period, rather than the opening and closing prices.
If the lower wick is longer than the body of the candle, it is known as a ‘hanging man.’ This is indicative that the price declined somewhat, but then recovered, which can be a sign of a bullish market, and therefore a good time to close open positions.
The opposite occurrence is known as a ‘shooting star.’ This is when the upper wick is longer than the body of the candle. The closing price should also be near to the low of the candle, which is indicative of a bearish market, and can help to inform decisions about when to enter the market, or alter stop losses to minimise risk.
Interesting fact: candlestick charts have been in use since the 18th century, when they were used by Japanese rice traders. They were only widely adopted by the West when Steve Nison published Japanese Candlestick Charting Techniques, in 1991.
How to decide which analysis tools to use
The charts that you use will depend on how familiar and comfortable you are with reading the charts, and what trading strategies you want to adopt. If you are a beginner, you will probably want to keep things relatively simple, and not overwhelm yourself with too much information at once.
It will also depend on whether you want to adopt a long or a short-term trading strategy. The shorter your trades, the more detailed information you will need, so studying bar or candlestick charts will be necessary. Longer term traders may be able to rely more heavily on line charts.
Other technical analysis techniques
The three charts discussed above are just a few of the technical analysis techniques that forex traders use. If you are a novice, they are a great place to start, because the charts are relatively easy to understand and use to read trends and patterns in price movement.
Once you become more expert you can then begin to learn all about Bollinger Bands, Fibonacci retracements, and pivot point indicators to really get to grips with in depth technical analysis.