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How To Analyse Forex Currencies
How To Analyse Forex Currencies
The below section forms part 2 of the Defensive Trading course in how to Trade and Invest in Forex. We will begin by looking at the various forms of analysis and then delve into the specifics of Fundamental and Technical Analysis.
Forms of Analysis
As with all forms of assets, there are two forms of analysing the price movements in the market. These are known as Fundamental and Technical Analysis. This will form the basis of this section of the course in Cryptocurrencies How To Analyse Forex Currencies.
Fundamental Analysis
For this course in How To Analyse Forex Currencies the significance if Fundamental Analysis cannot be overstated. This is the context of the markets that tells us what to trade. This is the analysis of the market based on the current or predicted economic, social and political factors that affect a market or currency. It is open to interpretation and is a constantly changing creature.
The market is a cruel mistress where Fundamental analysis concerned; it is possible for an asset to react in a way which is entirely inconsistent with what the fundamentals have indicated ought to happen.
It is also very common for an asset to react before the announcement of certain information has been released and the opinions and assumptions of politicians, economists and analysts to be ‘priced into the market’ days or even weeks in advance. In Fundamental Analysis, context it everything. It is the basis of forming market Sentiment.
Trading Tip: To keep track of all economic data releases, and therefore to understand the fundamentals, you will use your economic calendar.
It is important to remember that when we are talking about using Fundamental Analysis to trade a currency pair, we have to look at both sides of that pair.
Technical Analysis
When considering the Defensive Trading Course in How To Analyse Forex Currencies it is absolutely essential that you become familiar with all forms of Technical Analysis. This is the context of the markets that tells us when to trade.
Technical Analysis is a visual way of reading and interpreting of the charts.
It is used to analyse the historical price movements of a particular asset in an attempt to be able to determine what the likely future movements of that asset will be. In the same way that people all have their idiosyncratic tendencies, so to do financial assets.
Technical analysts base their decisions on the known behavioural price patterns of assets. Ironically, due to the foundation of Technical Analysis being on past behaviour, the predicted future behaviours can, at times, become self-fulfilling. This is due to the likelihood that most Technical traders will have their trades set up in similar ways.
Economic Indicators
The best way to summarise Fundamental Analysis is to use a phrase coined by James Carville in 1992 when campaigning for the soon to be President Bill Clinton, when he succinctly stated; “It’s the economy, stupid”.
When it comes to trading, we look more closely at an economy at large, by watching closely a variety of Economic Indicators from that economy. This makes up the biggest part of Fundamental Analysis.
Economic releases from an economy are, essentially, a health check of how well that economy is running. As with many things in life, how well something is running is usually directly correlated to demand for that particular thing.
For currency, the health check of the economy will affect the demand for a currency, demand made up mostly by investors. The behaviour of these investors usually seems to be quite fickle and it is not uncommon to see masses rush into, and out of, currencies – which in turn affects the price. It is fair, therefore, to say that economy affects price.
It isn’t always as simple as that, but it is generally true. This will become more apparent as we work through these Economic Indicators.
Here in this course in How To Analyse Forex Currencies we will cover in detail each of the Economic Indicators in the following.
Employment
What is it?
The Labour Market, also discussed as Employment, or rather Unemployment.
Employment is a key indicator of an economy’s health and Labour figures are released on a monthly basis. Usually a week after the end of the month whose figures are being released.
There are two ways of analysing this information:
How is it calculated?
Firstly, there is a sample survey taken of the population which is then calculated as a weighted average to indicate the overall position of the population.
Secondly, there is the claimant count. This figure indicates how many people have filed for unemployment benefits in that month, in other words, how many people have recently lost their jobs.
Why is this important?
If you think about it, it becomes very clear why this is such a big deal. Employee wages constitute household income and income equals spending power. The more people spending, the more business is generated in the economy, the more jobs are created, the more tax paid, and therefore the more money for all the participants of that economy, including the State.
An expanding economy is a healthy one where inflation will remain steady and interest rates will gradually increase to keep it in check. Higher interest rates make an economy more attractive for foreign investors due to the better than average return on investment.
Market Significance:
High
Effect on currency:
A positive release of employment figures, namely a low or decreased unemployment figure, would be perceived as being good news for an economy and therefore a currency. Conversely, a bad release where unemployment figures have increased is perceived as being a warning sign, or, a confirmation of troubled waters for an economy. This would make the currency less desirable to outside investors, which will have a negative effect on the currency price.
Consumer Spending
What is it?
Broadly speaking, Retail Sales, another key indicator of an economy’s health.
How is it calculated?
A survey of retailers is taken at random in the days following the end of the month.
It is important to note that this figure is an incomplete read on the total economy, as it is not indicative of the amounts being spent in the service industries such as air travel, insurance and entertainment.
Secondly, it doesn’t indicate units purchased, it indicates amount paid, so it can give a misrepresented read. If retailers have increased or decreased prices to account for external factors, the consumer will pay that at the register.
Why is this important?
Consumer spending accounts for approximately 70% of the activity of an economy and retail figures account for approximately 1/3 of that.
If people are happy to spend then it is a good sign that the economy is stable on a grassroots level.
Market significance:
High
Effect on currency:
This is one of the trickier indicators to get a handle on. From an external point of view, it would seem that higher retail sales would be a good indication that the consumer is in a good position, and therefore, would reflect well upon the economy.
However, it is important to remember that in this globalised world, many products are not locally sourced, or manufactured, and may be imported. This can result in a trade deficit whereby an economy is importing much more than they are exporting, which is actually bad news. Thus, always remember to check Trade Balance in addition to Consumer Spending.
Consumer Confidence
What is it?
This information collates data about how consumers feel about their jobs, the economy and spending.
Results range between -100 to +100. A positive reading indicates that consumers have an above average expectation of the future, conversely, a negative result will indicate that the expectation is negative.
How is it calculated?
As with other indicators, the data is collated from a survey of a randomised sample of the population.
Why is this important?
As outlined previously, the Consumer Spending is responsible for approximately 70% of economic activity, hence, a jittery and underconfident public is bad for spending, which is in turn bad for growth.
It has been highlighted over decades of data collection, that, at the household level, consumers are more adept at identifying an economy that is beginning to stal,l rather than one that is beginning to grow. This is thought to be due to the average household being more acutely aware of losing money than gaining it.
Market Significance:
Moderate, however, it can be a very significant precursor to a turning point in the economy.
Effect on currency:
A prolonged drop in Consumer Spending slows the growth of an economy, which will likely have an effect on the decisions of the Central Bank who will have to consider lowering Interest Rates to stimulate growth.
A lowered Interest Rate will in turn create less demand for the currency, as foreign investors will be better served allocating their capital to a higher yielding economy. This lack of demand will then decrease the price of the currency compared to any counterparts.
Consumer Price Index (CPI)
What is it?
Consumer price inflation is the speed at which the prices of goods and services bought by households rise or fall, and it is estimated by using price indices.
CPI is described as being like a very large shopping basket containing goods and services typically bought by households. The price index estimates changes to the total cost of this basket by calculating the average price changes of the items within the basket. It is the most used measure to calculate Price Inflation.
The measure is broken down into categories such as Food, Clothing, Transport, Housing and Leisure.
How is calculated?
CPI is what is known as a weighted Price Index, a weight is attached to a category to reflect significance.
This is as households spend more on some goods and services than others. Hence, we would expect, for example, a 10% increase in the price of petrol would have a much bigger impact on the basket than a similar rise in the price of sugar.
Why is it important?
CPI is an important indicator of how an economy is performing because it is the data upon which the Inflation Rate of an economy is derived, which has a direct impact to Interest Rates.
Market Significance:
Very High
Effect on Currency:
Broadly speaking, CPI data measures inflation in an economy. When inflation gets too high in a country, the Central Bank may increase Interest Rates in order to ensure price stability. This may cause the currency to rise in value as the additional interest received on the capital makes the currency more desirable to investors.
Housing
What is it?
This information gauges the residential property industry. Housing is actually a generalisation, the specific areas analysed are House Prices, New Home Sales, Exiting Home Sales, and Construction Spending.
How is it calculated?
Calculation is dependent on the specific kind of transaction that is being measured. For example, for constriction, a stat is counted when construction begins on the foundations of a residential building. For home sales, the figure is calculated after the transaction has completed.
Why is it important?
Historically, there have been exceptionally few instances of an economy running poorly during which the housing market has maintained its strength. In fact, Real Estate sector is credited with being one of the first to shut down when an economy nears recession, and one of the first to bloom when the economy starts to improve. This is largely due to the housing markets close relationship to interest rates, however, indirectly.
When the interest rates are high, it discourages the demand for loans and therefore mortgages. However, as interest rates fall, which happens during times of economic weakness, interest in buying homes is reinvigorated due to loans being more affordable.
Trading Tip: Just look the various Property booms that have taken place around the world in the wake of the latest Global Financial Crisis. In the decade that followed, almost all first world economies had interest rates that were historically low levels (often negative) for prolonged periods, making borrowing cheaper than ever in living memory.
Moreover, Construction, specifically, is dependent on the use of resources such as the employment of a workforce, steel, wood, electrical and gas resources, glass and concrete. It is easy to look at this industry and appreciate how the ‘multiplier effect’ will have a trickledown effect throughout the rest of the economy.
If people stop building or renovating houses, huge swaths of the economy will be negatively affected.
Market Significance:
Moderate
Effect on the Currency:
As with other economic indicators, strong housing reports are considered favourable for the direction of interest rates and therefore foreign demand for the currency.
Trade
What is it?
The Balance of Trade is the amount of goods an economy imports vs the amount of goods they export.
It is measured as a Trade Deficit (more imports than exports) or a Trade Surplus (more exports than imports).
How is it calculated?
Every month total exports such as agricultural or manufactured goods are compared to goods imported.
Each economy is slightly different in terms of goods produced such as mechanical, computing, vehicles, aeronautical, weapons, pharmaceuticals, mined resources, meat or farmed products.
Why is it important?
Trade contributes to Gross Domestic Product (GDP).
An economy’s dependence on imported goods makes it more susceptible to and sensitive to change that may affect the economy from whom they import those goods. That change may be natural or political.
Market Significance:
Moderate
Effect on the Currency:
If a country imports more than it exports, there is less demand for its currency due to perceived increased risk, so in the case of currency, it loses value.
It is desirable for an economy to have a trade surplus to make it a more desirable and stable place in which to invest.
Purchase Managers Index (PMI)
What is it?
PMI tracks activity in manufacturing, retail and construction sectors and assess the level of new orders, however, there is also a non-manufacturing PMI.
A measure of more than 50 represents expansion of the manufacturing sector when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change.
How is it calculated?
PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.
Why is it important?
There is a direct link between manufacturing output and employment.
Market Significance:
High
Effect on the Currency:
As this indicator is a measure of the activity in an economy, a positive result is perceived as being good news for an economy and will therefore have a favourable effect on investor’s perceptions of its strength and future growth projections.
Interest Rates
What is it?
An Interest rate is the cost of borrowing money, expresses as an annual interest rate and is set by the Central Bank.
How is it calculated?
An interest rate is not so much calculated as it is set by the Central Bank of an economy, known as the ‘Base Rate’.
The decision to increase, decrease or keep the same the interest rate of an economy is based on the detailed analysis of all the aforementioned economic indicators, in addition to others that would affect a particular economy specifically.
This will indicate the rate that Banks and other lenders should both charge, and pay, to borrowers and depositors respectively.
Why is it important?
Because the Interest Rate is a throttle for an economy. It can be used to both cool or to encourage growth, by helping to regulate how cheap or expensive it is for consumers to borrow money that they will invest back into the economy.
Market Significance:
Very High, however, changes are usually priced in in advance.
Effect on currency:
The higher the Interest Rate the more favourable the return investor will receive on money invested, therefore, increasing demand for that currency, in turn driving up the price.
Gross Domestic Product (GDP)
What is it?
It is the measure of National Output. It is the total value of all goods and services made in that economy.
How is it calculated?
GDP = private consumption + gross investment + government investment + government spending + (exports – imports)
It can be given as Nominal GDP or Real GDP. Real GDP accounts for inflation.
Why is it important?
It is an overall barometer of the health of an economy and can be used to analyse where an economy is heading.
It is used gauge if a nation’s economy is growing healthily or contracting in a recessionary environment.
Market significance:
High
Effect on Currency:
When the GDP for a country comes out higher than the market is expecting, it is usually positive news for the currency of that nation. Based on such good news, that currency will often appreciate relative to other currencies.
Central Banks and Monetary Policy
What is it?
The Major Currency Central Banks are as follows; US Federal Reserve (the Fed), The Bank of England (BOE), The European Central Bank (ECB), The Swiss National Bank (SNB), The Bank of Canada (BOC), The Bank of Japan (BOJ), the Reserve Bank of Australia (RBA), the Reserve Bank of New Zealand (RBNZ) etc.
Central banks set the interest rates of an economy and its monetary policy.
Monetary policy is a central Banks attempt to retain control and the predictability of growth of an economy, in turn creating stability.
When that doesn’t happen, Monetary Policy is the attempt to get the economy back on track.
How is it calculated?
The scariest thing about studying economics is realising that the people who discussing which economic theories to implement are actually making an educated guess on what the effects will be and, to a large degree, trying to figure out and understand why events took place in the past. So, it isn’t ‘calculated’ in the traditional sense of the word. It is more of an educated guess, which is called ‘Economic Modelling’.
Why is it important?
The faster and longer the economy grows, the higher the level of employment, which increases household income, which increases household expenditure whose demand then fuels companies to increase production, which requires further employees, which in turn further increases household income, which then increases demand for foreign products. Thus, it continues. In theory.
Market Significance:
Very high
Effect on Currency:
Everything a Central Bank does is in order to bring the Economy back on-line. This means that in times of trouble, we see actions that are aimed at stimulating an economy. Conversely, an economy that is running smoothly will be kept in check, preventing it from becoming ‘overheated’.
Trader Tip: You will hear the terms Dovish and Hawkish when listening to reports of the language used by Central Bankers when discussing the economy, the monetary policy, its implementation and their forecasts.
Consensus
A Consensus is the agreed upon result for an economic data release. The top economists from public and private institutions, make an estimate of what they believe the unemployment figure might be, for example.
After all the estimates have been collated and averaged, then the consensus figure is published.
This is used as a guide, however, if the real result differs enough from the consensus figure in either direction, this can have a very significant effect on the markets.
Results fall into one of three categories. As expected, better than expected or worse than expected.
Depending on the market conditions at the time, and the overall trader position on a currency, these can affect the markets in a variety of ways. There is definitely no hard and fast rule to data release.
For example, a positive jobs report might be released, making you think that the currency should strengthen, but it doesn’t. This doesn’t seem to make sense, until you realise that the positive jobs report came out during a holiday period which always sees higher rates of employment due to temporary seasonal workers being taken on. In addition, this report comes out just after disappointing housing data had been released. You can see now why this ‘positive’ jobs information was not perceived as being a game changer by those who are looking at the market as a whole.
In addition to the above example, there is also another effect on the markets which can mute the effects of a seemingly important data release. This is known as being “Priced in”. This occurs when traders have seen a long way out the coming change and aren’t phased when it actually happens.
For example, if the Central Bank of an economy raises the Interest Rate after a period of steady growth and constantly reliable inflation data and acceptable housing and employment data, then traders see it as being a ‘no brainer’.
In addition to this, Central Bankers tend to be very transparent about their intentions and the conditions that they are waiting on before they take action to raise or lower an interest rate. To that end, traders can be caught off guard and this does happen, but it is not the norm.
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Country Specific Indicators
The next element of this course in How To Analyse Forex Currencies is the country specific indicators which offer further information about the specific characteristics of an economy which was outlined in Ultimate Course in How to Trade Forex – Part 1 – An Introduction to Trading Forex.
USA
Non-Farm Payrolls (NFP)
Non-Farm Payrolls –NFP is actually the most anticipated data release on the entire monthly calendar and is released the first Friday of every month.
The US Bureau of Labor Statistics release a measure of the net changes in employment as jobs are created or subtracted in any given month, excluding agricultural workers, hence non-farm. This removal is done to remove any sensitivity to seasonal employment fluctuations.
It is the most comprehensive employment number released in the United States and has been known to produce high volatility in the markets.
University of Michigan Survey of Consumer Sentiment
University of Michigan survey of consumer sentiment is a consumer confidence index published monthly
At least 500 telephone interviews are conducted of a continental United States sample (Alaska and Hawaii are excluded) during which fifty core questions are asked.
It’s market value in the US is, similarly to NFP, due to its real time collection and therefore its ability to inform on the current situation in the economy, not one that is long gone.
Please be aware that the University of Michigan provides Thomson Reuters news service with the data early, so that Reuters can release the CSI to select, paying clients at 9:55 a.m., before it releases the data to the general public on its web site at 10:00 a.m. In addition, Reuters releases the data via high speed communication channels to select clients two seconds earlier.
Canada
Interestingly Canada was one of only two economies to get through the GFC comparatively unscathed, the other was Australia. How is this possible? Well, because both economies have an abundance of high-grade natural resources as well as a highly skilled workforce particularly in the manufacturing sector. In fact, the success of the Canadian economy is due to them being interdependent.
Canada’s economy is broken down into three segments, Resources, Manufacturing and Services.
Ivey Purchasing Managers Index
Ivey Purchasing Managers Index is a diffusion index incorporating survey results conducted on companies throughout the country.
Policymakers and traders watch these surveys closely as purchasing managers usually have early access to data about their company’s performance, rather than waiting for the hard data to emerge.
Europe
When we talk about Europe, we are discussing Germany and the rest. The German economy is responsible for in excess of 50% of the GDP of the entire Eurozone. For that reason, we are focused mainly on German indicators when we talk about Europe.
German ZEW Indicator of Economic Sentiment
The German ZEW Indicator of Economic Sentiment is a popular indicator of the condition of the German economy as it is released the same month as the survey covers which increases its value to traders and investors.
Japan
Japan as an economy has been hit time and time again since the 1980s. They have suffered a severe stock market and real estate crash which caused recession after recession during the 1990s. After this ‘lost decade’ had passed, it appeared that Japan may be on the road to redemption, however, then fate stuck again, and Japan was hit with a severe earthquake and tsunami in 2011 which caused the meltdown of the Fukushima Nuclear reactor resulting in large swathes of land to becoming radioactive.
These issues are now being overcome; however, Japan still faces other problems such as an aging population, high public debt, reliance on exports for growth and a heavy reliance on imports for fuel needs.
Despite that, however, it is an industrious nation and exports $850 Billion of goods and services every year, making it the world’s third largest economy (after the US and China).
Tankan Survey
Tankan Survey is a quarterly survey undertaken by the Bank of Japan. As with other direct surveys, a range of questions inquire directly to businesses of all sizes and types for current conditions and expectations.
It is viewed as being significant in the market because it has a response rate of around 98% from those surveyed, which is unparalleled. So too, the comprehensiveness of the survey is unparalleled.
China
No country has ever displayed such a sustained rate or growth as what The Peoples Republic of China has maintained for three decades. It is still, however, considered an emerging economy because its GDP per capita (per person) is still among the lowest in the world.
Summary of Commentary on Current Economic Conditions (The Beige Book)
The Chinese Beige Book was established in 2010 and is actually published by the US Federal Reserve Board. It was foundered in order to increase transparency and to provide external investors a more reliable economic snapshot than what was customarily offered by the official Chinese Government channels. It incorporates a wide range information ranging from anecdotal hearsay to data-based inferences.
Australia
As mentioned earlier, Australia is one of the two advanced economies to have side-stepped the GFC, along with Canada. Though, in actual fact, Australia fared better. Prior to the Covid-19 outbreak, Australia had not slipped into recession since 1991 which is one of the longest periods of continuous expansion of any Economy on record.
This is largely due to Australia’s geographic location promoting some enviable trade partners, the largest of whom is China, in addition to Australia being very resource rich.
The possible downside of this is that if the Aussie economy does too well, this will push up inflation, causing interest rates to have to follow suit, which will push up the value of the Aussie Dollar, in turn making their goods more expensive to foreign buyers which will then put the economy at risk.
Australia is also very sensitive to Chinese data release as they are their biggest trade partner. For that reason, it is not uncommon to see a reaction in the Aussie Dollar from Chinese data.
International Trade
International Trade data release is watched closely by traders as it accounts for 40% of Aussie GDP. It is focused on not only as a barometer of health but also as a forecasting tool.
Trading Tip: Remember that CPI, PMI, GDP, monetary policy statements and meeting minutes are big everywhere as is unemployment etc. The above list is just a few honourable mentions.
Now that completes the Fundamental Analysis section of this course in How To Analyse Forex Currencies, next we start with the section about Technical Analysis.
Technical Analysis
This section of the course in How To Analyse Forex Currencies we will explore the wide array of chart based patterns that are used by traders universally to give them some guidance as to when they should be entering their trades, and how much movement they expect to be getting out of any given trade. This is done through visual and fundamental aspects such as Support and Resistance lines etc.
Price Action
Price Action, also known as ‘Naked Trading’, only considers on the price movements of an asset as seen on the chart.
It focuses on the historical data and does away with Fundamental Analysis and Technical indicators, however, it is a form of Technical Analysis.
They focus on things like trend lines, price bands, high and low swings, technical levels of support, resistance and consolidation.
It utilises elements such as simple price bars, price bands, break-outs, trend-lines, or combinations involving Candlesticks Patterns, Chart Patterns and Volatility.
Because of the interpretive nature of Price Action trading, it is rare that two traders will trade price action in the same way.
Let’s take a more detailed look into this style of trading.
Support and Resistance Zones
No course in How To Analyse Forex Currencies would be complete without a thorough explanation of Support and Resistance lines. Support and resistance zones are the Price Action traders most valued form of analysis.
Zones are slightly different to Support and Resistance levels because they are not a specific price point, but an area, and therefore shouldn’t need to be adjusted.
They are significant because they have been tested and retested over time. In addition, they have a historical tendency to cause a reversal of a trend and thus, become better with time.
These zones can seem a little bit tricky find for those who are new to trading. Here are a few tips to help with that:
1. Use a high timeframe, do weekly, daily charts.
2. Using a line chart, instead of a candlestick chart as a line chart will show the closing price.
3. Don’t focus on minor areas. (reversal levels are more significant)
Trading Tip: When you are looking for support, resistance or trend lines, make sure to always sure that you let the market fit the lines and don’t try to make lines fit the market, or they will be useless.
Trendlines
Trendlines are essentially the same as traditional horizontal Support and Resistance levels, however, they are on a diagonal trajectory. (Uptrend or Downtrend)
It is generally accepted that three touches on a line are required to confirm the trend, however, two touches are the minimum to establish the trend.
The more times the trend line is tested, the stronger the trend becomes.
1. Uptrend – when the price is consistently displaying higher highs and higher lows.
2. Downtrend – when the price is consistently displaying lower highs and lower lows.
3. Consolidation – when the market is moving in a set range, neither making higher highs nor higher lows.
Channels
Channels area very similar to trend lines, however, they are a set of two lines which run exactly parallel to each other offering Support and Resistance to a trending asset. (Uptrend or Downtrend)
As with trend lines, there are three kinds of channels:
1. Ascending Channel – when the price is consistently displaying higher highs and higher lows in a parallel range.
2. Descending Channel – when the price is consistently displaying lower highs and lower lows in a parallel range.
3. Horizontal Channel when the market is moving in a set range, neither making higher highs nor higher lows in a parallel range.
Candlestick Patterns
The next area of our focus in this course in How To Analyse Forex Currencies is to start assessing the significance of the actual chart formation itself. This starts with Candlesticks.
The study of Candlestick Patterns focuses on the intentions of the market based on a visual interpretation of form of anywhere from one to three candlesticks. As with many indicators in Forex, the combinations will indicate one of three future movements of an asset: reversal, continuation or bilateral (sideways).
Before we delve into the inferences drawn from the specific appearance or behaviour of the candlestick, or combination of candlesticks, we must first establish the elements of the candlestick itself.
The below diagram indicates the various basic elements of a generic candlestick from which we can compare the various indicative appearances below.
As you can see, the Bear candlestick contains the exact same elements as the Bull candle save as to the open and close points.
The study of candlestick patterns leads neatly into the more robust (and significant) study of Chart Patterns which are in my experience more reliable. Notwithstanding, there are a few outliers that you will notice appear consistently in the charts, and are the most dependable in this field of Analysis.
Interestingly they are the single candlestick formations. With experience, you will become very familiar with these forms, however, as a beginner study this list carefully and make sure to refer to it regularly throughout your trading.
Single Candlestick Indicators
- Spinning top: Indecision, possible reversal.
- Doji(s): Sign of indecision, an indication that the buyers/ sellers are becoming exhausted and a reversal is possible
- Hammer: Bullish, potential reversal.
- Hanging Man: Bearish, potential reversal.
- Inverted Hammer: Bullish, possible reversal.
- Shooting Star: Bearish, possible reversal.
- Marubozu: Either very bullish or very bearish depending on direction (see Engulfing Candle and Tweezer bottoms / Tweezer tops)
- Evening Stars: These are triple candlestick patterns that can indicate the end of a trend and a potential reversal.
- Morning Stars: These are triple candlestick patterns that can indicate the end of a trend and a potential reversal.
Trading Tip: Reading charts can be a likened to learning a language or learning to read sheet music. Initially it seems very difficult one note from another, however, with time and practice comes the ability to see the most minor elements with great clarity.
Multiple Candlestick Indicators
Reversal Candlestick Patterns
Continuation Candlestick Patterns
Chart Patterns
The next area of the course in How To Analyse Forex Currencies takes a closer look at what happens when many of these candlesticks begin to form larger patterns. These are referred to as Chart Patterns. Of these two forms of chart analysis, Chart patterns are the most significant and dependable. This is largely as they incorporate a much larger period of time and when considered, display a more logical depiction of the pricing situation.
Double Top
Bearish. Indication of reversal. Comprised of two touches at a resistance point that cannot be broken by the buying power. Generally, appears after a strong upward move or trend.
Double Bottom
Bullish. Indication of a reversal. As with the double top, it comprised of two touches but this time at a support level. The sellers cannot break below. Generally, appears after a downtrend or strong downward move.
Head and Shoulders
Bearish reversal pattern. Comes after a uptrend. Made up of three peaks, with the central peak being higher than the other two. Most reliable when the angle of the neckline is sloping downwards, meaning that the last low is lower than the first and second lows.
Inverse Head and Shoulders
Bullish reversal pattern. The opposite of the above head and shoulders pattern. The central trough is lower than the outer two. Comes after a downtrend.
Diamond
A reversal Pattern. Diamonds are a variation of the Head and Shoulders chart pattern. While it is extremely rare, this pattern signals a break in trend much more quickly than a head and shoulders pattern. To use, take the distance between the highest and lowest point in the diamond formation and add it to the breakout point.
Rising Wedge
Bearish. It can be an indication of a reversal or continuation of a trend depending on the preceding trend. The key with a wedge is that it is a form of consolidation. It is different from a channel because the trajectories that the lines are tracking are not parallel, but converging.
Falling Wedge
The same but opposite to a rising wedge. Bullish. It can be an indication of a reversal or continuation depending on the preceding trend.
Rectangles
Can be bearish or bullish. A ranging market. A period of consolidation before a continuation. Essentially a horizonal channel where the asset is caged in by certain support and resistance points.
Pennants (see Symmetrical Triangle)
Trend continuation indication. Can be bullish or bearish depending on the preceding trend direction. It is a short period of consolidation before a continuation.
Symmetrical Triangles
Bilateral chart formation. It is a period of consolidation and is characterised by lower highs and higher lows. It is an indication that the price is preparing to make a break.
Ascending/ Descending Triangle
As above, is a period of consolidation and will have either horizontal support or resistance. It is an indication that the price is preparing to make a break, however, that could be in either direction.
Technical Indicators
This brings us to the third key area of Technical Analysis in this course in How To Analyse Forex Currencies which is the much misunderstood Technical Indicators.
There are two kinds of indicators, Leading and Lagging.
As the names would indicate a leading indicator gives a signal before the new trend occurs, and conversely, the lagging indicator provides a later signal after the trend has started. Each has positives and negatives, one is delayed (lagging) but the other will give ‘fake’ indications (leading).
Generally speaking, leading indicators are oscillators and lagging indicators are trend following or momentum indicators.
Simple Moving Average (SMA)
Nature
Trend indicator as a line chart. Moving averages are a way of using a line chart to view the average of the closing price for a set period, on a continuous basis.
Common times are 20, 50 and 200. (See Crossover in Part 4 – Strategy)
The larger the period included, the less responsive the indicator becomes.
Pros
They can also offer dynamic support and resistance lines. They smooth out the price so that you can see a clear indication of direction.
Cons
As they as based past data and therefore their response is delayed.
Exponential Moving Average (EMA)
Nature
Trend indicator as a line chart. As above: Moving averages are a way of using a line chart to view the average of the closing price for a set period, on a continuous basis.
Common times are 20, 50 and 200.
Pros
The larger the period included, the less responsive the indicator becomes.
Cons
They can also offer dynamic support and resistance lines. Unlike SMAs, EPAs smooth out any one-time spikes caused by a price surge from a news release or similar event. This is because they weight the most recent periods where SMAs will give each time period equal weight. EMAs can cause ‘fake’ indications as they can be too responsive.
Trading Tip: MAs are only useful when use in combination of 2 or 3 at one time. A combination of SMAs and EMAs may be used on the same timeframe, or a combination of either SMAs or EMAs on different time frames as indicated above. This will create the ‘Cross Over’ strategy. For more on Cross Over see Part 4.
Bollinger Bands
Nature
A volatility measure. Appears as line charts. Calculated price and volatility over a set period of time inclusive of standard deviations.
They represent a maximum and minimum moving average. The more volatility the wider the bands are apart (loud), or less volatility when the bands are further apart (quiet).
Pros
Can be used to trade the ‘Bollinger Bounce’. They are simple, reliable and don’t dazzle the eye too much to detract from the underlying charts movements.
Cons
Only a small piece of the puzzle, while knowing and understanding volumes is very helpful, you cannot rely on it alone.
Moving Average Convergence Divergence (MACD)
Nature
Momentum indicator in a trend. Line chart and histogram. Made up of 3 measures, a fast-moving average, a slower moving average and the difference between the two displayed as a histogram. Normally, 12, 26 and 9.
Though the formation can on occasion be similar to a sign-wave formation, more often than not, it will not take this formation.
Pros
Only gives signal once the trend has been established.
Cons
Can be delayed.
Parabolic SAR (stop and reversal)
Nature
Oscillator signals the end of a trend or a reversal. They indicate an exit point for a currently running trade.
Pros
Very easy to understand and use.
Cons
As with many other indicators, it us best used in a trending market otherwise it can just give ‘fake’ indications.
Stochastic
Nature
Oscillator indicator used to signal the end of a trend. It is a line chart. Measures if an asset is overbought or oversold. Made up of a faster and slower measure. Gives a reading in the range between 0 to 100, with over 80 being considered overbought territory, and under 20 being considered oversold territory.
Generally, moves in an irregular sign curve formation.
Pros
Creates a condition called divergence, which is a trade set up.
Cons
Markets can linger in overbought or oversold territory for extended periods, during which time the price can continue to extend further in that direction.
Relative Strength Index (RSI)
Nature
Oscillator to signal the end of a trend. Displayed as a line chart. Similar to a stochastic, identifies overbought and oversold territory of an asset. However, while it also ranges from 0 to 100, distinctly, it uses levels of 70 and 30 to indicate overbought or oversold territory respectively.
Pros
Creates a condition called divergence, which is a trade set up.
Cons
Markets can linger in overbought or oversold territory for extended periods, during which time the price can continue to extend further in that direction.
We hope you have enjoyed this Ultimate Course in How to Trade Forex – Part 3 – How To Analyse Forex Currencies. Please check here for more courses from Defensive Trading.
If you would prefer you can purchase The Definitive Guide to Defensive Trading Forex book on Amazon.
If you would prefer to continue the course online then please take Part 4 below.
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