Technical analysis is a tool that traders use to evaluate past price actions and predict future price movements in the forex market. Traders can use different technical indicators and trading strategies, but it is essential to remember that no single indicator or strategy is perfect. Traders should use technical analysis as a part of their overall market analysis and decision-making process.
An important thing to remember when using technical analysis is that prices move in trends. A trend is simply a direction in which prices are moving over time. Trends can be up, down, or sideways. Most technical indicators are designed to identify these trends and help traders make better-informed trading decisions. To learn more about using this tool, read more here.
Identifying trends with moving averages
Moving averages calculate the average price of a security over a given period. They are often used to identify trends and support and resistance levels. There are many moving averages, but Simple Moving Averages (SMAs) and Exponential Moving Averages (EMAs) are the most commonly used.
To calculate an SMA, you add up the closing prices of a security over a given period, then divide the balance by the number of periods.
EMAs are similar to SMAs, but they give more weight to recent data, making them more responsive to changes in price direction. To calculate an EMA, you first calculate the SMA and then apply a weighting factor.
The most common moving averages used in forex trading are the 20-period, 50-period, 100-period, and 200-period EMAs. Traders can use these moving averages to identify the market’s overall trend.
When prices are above the 200-period EMA, it is generally considered an uptrend. Similarly, when prices are below the 200-period EMA, it is typically considered a downtrend. Traders can use the 20-period and 50-period moving averages to identify short-term trends.
Identifying support and resistance levels
Support and resistance levels are important technical indicators that traders use to determine where to enter and exit trades. These levels are created when the price of a security stops moving in one direction and reverses course.
Support levels form when the price of a security is falling and then begins to rise. This level is created because there is an increased demand for the security at this lower price. The demand eventually overcomes the selling pressure and the price rises.
Conversely, resistance levels form when a security’s price rises and begins to fall. This level is created because of increased selling pressure at this higher price. The selling pressure eventually overcomes the buying pressure, and the price begins to fall.
Traders can determine support and resistance levels using various technical indicators, but the most common are horizontal support and resistance lines, Fibonacci retracement levels, and trendlines.
Using Bollinger Bands®
Bollinger Bands® are a technical indicator that is used to measure volatility. They are created by adding and subtracting a standard deviation from a moving average. Bollinger Bands® can be used to identify trends and support and resistance levels.
When the price of a security shows an uptrend, the Bollinger Bands® will expand. This expansion is due to the increased volatility that accompanies an uptrend. Similarly, when the price of a security is trending down, the Bollinger Bands® will contract. This contraction is due to the decreased volatility that accompanies a downtrend.
Traders can also use Bollinger Bands® to identify support and resistance levels. When the price of a security is trading near the upper Bollinger Band®, it is considered overbought and a potential sell signal. Contrarily, when the price of a security is trading near the lower Bollinger Band®, it is considered oversold and a potential buy signal.
Using candlestick charting
Candlestick charting is a technical analysis tool traders use to visualise price movements. Candlesticks are created by plotting a security’s open, high, low, and close on a graph.
Traders can use candlesticks to identify trends and support and resistance levels. When the candlesticks are clustered together, the market consolidates. It often happens before prices make a big move in either direction.
When the candlesticks are trending up, it indicates an uptrend. Similarly, when the candlesticks are trending down, it indicates a downtrend.
Traders can also use candlesticks to identify support and resistance levels. Prices trading near the candlestick’s top are considered overbought and are a potential sell signal. Conversely, prices trading near the bottom of the candlestick are considered oversold and are a potential buy signal.