Introduction to Technical Analysis - Part 2
In Part I of our introduction to technical analysis, we simply discussed some basic information about this type of analysis and compared technical analysis to fundamental analysis.
In this second article about FOREX technical analysis we will look at the various kinds of charts and provide some basic guidelines for reading charts. If you have any familiarity with technical analysis of stocks, you will recognize most of the charts and techniques mentioned.
Price Charts
Price Charts show information about FOREX prices at specified intervals of time. Intervals can be anywhere from one minute up to several years and everything in between. Prices may be plotted with simple line graphs or the price variation for each interval can be shown by a bar or candlestick pattern.
Line charts are suitable for giving a broad overview of price movements. They show the close price for each of the chosen intervals. Line charts are very clean to read and make it easy to spot patterns, but they do lack the detail and depth of information of bar and candlestick charts.
Bar charts offer much more information than line charts. The length of each bar normally indicates the price spread for the given period – a long bar indicates a large difference between high and low prices. The left tab on the bar shows the opening price and the right tab shows the closing price. At a glance you can see whether the price fell or rose for that particular period, and what the price variation was. Bar charts printed on paper (especially for short periods) can be difficult to read, but software charts usually have a zoom function that makes it easier to read the information on closely spaced bars.
Candlestick charts were invented by the Japanese for the purpose of analyzing rice contracts. They are similar to bar charts in that they indicate open, close, high and low prices for a given period. They are easier to read than bar charts, however, because of their color coding. Green candlesticks show rising prices and red candlesticks show falling prices. How simple is that?
Candlestick shapes - when viewed in relationship to neighbouring candlesticks - can provide indicators of market movement that aid in chart analysis. Various shapes of candlesticks are formed according to price spread and the proximity of opening to closing prices. Candlestick patterns have been given fanciful names like 'morning star' and 'dark cloud cover' and once the shapes have been learned, they are easy to pick out on a chart for the purpose of identifying trends in the market.
Price charts are usually supplemented with various technical indicators. There are many Technical Indicators broadly divided into different categories. Trend indicators, strength indicators, volatility indicators, and cycle indicators are just a few of the analytical tools used to anticipate movement and market volume.
Some of the most common technical indicators used in FOREX are:
Average Directional Movement Index ADX is used to determine if a market is entering a trend (either downward or upward) and how strong the trend is. Readings over 25 indicate a trend with higher values indicating stronger trends.
Moving Average Convergence/Divergence MACD shows the momentum of the market and the relationship between two moving averages. When the MACD line crosses the signal line it indicates a strong market.
Stochastic Oscillator The stochastic oscillator indicates the strength or weakness of a market by comparing a closing price to a price range over a period of time. When the stochastic is above 80 it indicates the currency is overbought while a stochastic below 20 indicates the currency is oversold.
Relative Strength Indicator RSI is a scale of 100 indicating the highest and lowest prices over a given period. When the price rises above 70 it is considered overbought and when the price falls below 30 it is considered oversold.
Moving Average The moving average is the average price for a given time interval when compared with other prices during similar time periods. For example, the closing prices over a 3 day period would have a moving average of the total of the 3 closing prices divided by 3.
Bollinger Bands The Bollinger bands are bands which contain the majority of a currency's price. The bands are three lines – the upper and lower lines following the price movement and the middle line showing the average price. During times of high volatility the distance between the upper and lower bands widen. If a bar or candlestick touches one of the bands it indicates overbought or oversold conditions.
