When it comes to trading decisions, it makes sense to take advantage of what traders have learned over the years about the markets, rather than steer your trading boat all by yourself. Trading CFDs doesn’t have to be like rowing your canoe into a thunderstorm. Experienced traders plan their approach before entering into trades and then follow their strategies for more insight. For example, when the price of a forex trading instrument such as EUR/JPY is low, and a trader feels it may increase, he could be inclined to open a ‘buy’ deal or go long. Conversely, when its price is high and he feels it may decrease, he could be inclined to open a ‘sell’ deal or go short. A disciplined trader, however, will not only follow his natural inclination, but also stick to his strategy. Nobody says that trading strategies are guaranteed to work every time, but many traders choose to use them so that their approach will be based on solid data rather sentiment or emotion.
What is technical analysis?
Technical analysis is a common forex trading tool utilized by traders to gain insight into how an instrument has performed, in order to get a better idea about what it may do next. Traders analyse historical market activity, in particular the price and volume of an instrument over time, in the belief that these price movements actually reflect important information about its value. They also believe that the movements of prices happen in trends. Another way of saying this is that prices may continue to move in the same direction they are moving until a technical indicator suggests there will be a reversal. Finally, traders are convinced that trends in market psychology repeat themselves. All this combined makes technical analysis both intuitively interesting and highly valuable for those traders who seek to structure their approach to the markets.
Technical analysis is particularly useful in the forex market. Those who trade in currency pairs like EUR/JPY or USD/MXN know that the forex market can be volatile. This kind of analysis helps traders understand the psychology, or the sentiment, of market participants in general. Through this, they hope to glimpse a broader view of the forex market and how their chosen forex instrument may perform in a particular timeframe. Let’s take a look at three of the most commonly used methods of technical analysis in forex trading.
This interesting method is based on ratios found in various parts of nature. On a graph showing recent market activity, a trough and peak are chosen for analysis. The distance between them is divided by the key Fibonacci ratios. The result helps traders predict when a downward or upward trend might pause and steady out. As with other kinds of analyses used in forex trading, this one has its drawbacks. It is not clear to traders which Fibonacci level should be useful at a given time. In addition, they are unsure whether or not the price of the security will stop at the point where it steadies out.
John Bollinger designed this method to determine when an instrument is oversold or overbought. Bollinger also based his approach on the graphing of historical data. When prices move close to the upper band, the market may be overbought. When prices move close to the lower band, the market may be oversold. There are many enthusiasts of this method, and its designer also proposed 22 rules to follow in using the system. It does not, however, tell us when the change will take place, or in which direction the price will move.
MACD (Moving Average Convergence Divergence)
This method of analysis tries to spot changes in price trends. Traders use it to understand whether a bullish or bearish movement is strengthening or weakening. It works by drawing a MACD line on a graph, (this is created by subtracting the 26-period moving average from the 12-period moving average) and comparing it to a signal line. If it is above the signal line, a bullish (upwards) trend is indicated. If it is below the signal line, a bearish (downwards) trend is indicated. Use of the MACD does sometimes result in predictions of reversals that don’t occur, so many traders use it in conjunction with other technical analysis strategies.
It’s important to gather as much relevant information as possible about your trading instruments, especially for those involved in forex trading as CFDs, where it is possible to take advantage of price movements in both directions – up and down – without having to purchase the underlying asset. To ease your way toward using technical analysis, check out the YouTube channel of regulated broker platforms, where you can find useful video tutorials on a variety of topics.