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Tips for Improving Your Forex Technical Analysis
06/04/2009 12:01 am EST
Reading and analyzing charts is the core of technical analysis, and it is something that you get better at with time and experience-so don't be surprised if you don't understand absolutely everything on your first try. You can learn more about forex technical analysis by watching the video that accompanies this article.
In the video, I referred to an article about the danger of adding too many indicators. You can find that here.
While reading and analyzing charts is important, if it's not harnessed correctly, it can also become almost hypnotizing and lead to "ticker-itis," a dangerous condition that borders on obsession as a trader spends more and more time staring at charts and indicators and less time making fundamentally sound trading decisions and controlling risk.
Technical analysis is extremely effective, but it is also a subjective art form. Show the same chart to two technicians (which is fun to try), and they are likely to come to similar conclusions but possibly through very different means and details. And in some cases, they may not come to the same conclusion at all. So let's get started with the basics of technical analysis.
Forex charts plot a currency pair's price movements over time. On most charts, time is plotted from left to right on the X, or horizontal, axis, and price is plotted from bottom to top on the Y, or vertical, axis. While most charts are built on this basic setup, each type of chart-from line charts to candlestick charts-illustrates price movement differently. Each chart type has specific advantages and disadvantages, and you will need to find the chart type that works best for you as a trader. Here are a few things you need to know.
Time Is Important
Each data point on the chart, whether it is shown as a line, candle, bar, or box (all discussed later), represents a specific price at or within a specific point, or interval, in time. Short-term traders may have their charting intervals set for 30-minute increments or shorter, while longer-term traders will often use daily increments.
Here's an example. Take a look at the two charts below-both of which are spanning the same length of time. The shorter-term (four-hour) chart on the right shows a lot more detail than the daily chart on the left, but which one is better? Detail can be nice, but it can also be confusing. The answer depends on what type of a trader you are.
Chart Time Frame Comparison
What's Your Type?
Chart types come in many shapes and sizes. You have the ability to illustrate each interval of time on a chart in any way you want. Here are the most common types of charts and samples below:
Candlestick charts: Most forex traders use candlestick charts in their trading and analysis. Candlesticks show the opening, high, low, and closing prices for each trading period. The body, or rectangular portion, of the candlestick shows the open and close prices, and the wick of the candlestick shows the high and low prices. We use candlestick charts for our own analysis at LearningMarkets.com.
Line charts: Some traders use line charts, which only show one price-usually the closing price-for each period. Line charts are certainly easy to read, but they leave out a lot of detail.
Bar charts: Bar charts are similar to candlestick charts, but many traders feel they are more difficult to read. A bar chart shows the opening and closing prices as horizontal tick marks on a vertical bar that shows the period's total trading range.
Exotic styles: Some traders have come up with other, more unusual ways to chart price movement-typically to accommodate a specific style of analysis as well as to show price movement. For example, the chart on the lower-right below is a Renko chart, which shows price movement but does not progress linearly through time.
MORE: Tips for Avoiding "Analysis Paralysis" |pagebreak|
Chart Type Comparison
Indicators and Drawing Tools
Many traders will layer trend lines, technical studies, and moving averages on top of their price charts. Most dealers' charting applications include many of these studies, indicators, and line tools. At LearningMarkets.com, we use trend lines and Fibonacci analysis quite frequently.
Technical studies can be useful, but can also be abused by traders. The biggest danger traders face when using charting tools is "analysis paralysis." At some point, you have to make a decision about your trade, and simply adding more analytical tools that may just end up muddying the water does not necessarily increase your probability of success. "Indicator piling," or adding several indicators to a single chart, will probably only obscure your real trading opportunities.
If your charts start to look like the one on the left rather than the one at the right, it may be time for you to reevaluate how much time you are spending adding indicators.
Indicator Piling Comparison Charts
Some Basic Charting Tips:
1. Keep your chart analysis as simple as possible. Most successful traders refrain from "ornamenting" their charts with too many indicators or tools.
2. Learn about the various chart types available to you as a trader, choose one, and stick with it. We recommend learning to use candlestick charts, but if you prefer another chart type, go ahead and use it. Just remember to stay consistent. Shifting from one chart style to another can be disruptive to your learning process as you are starting out in the forex market.
3. Pick a timeframe that matches your trading style. If you are a very short-term trader, hourly charts or even shorter ones may be the most effective choice for you. However, if you are looking for trades that last days or weeks, the hourly charts may have too much "static" to be useful, and the daily charts may be more appropriate.
4. Invest in the right charting package. Some good dealers out there offer great charting software that come free with your account. Try them out, and see who you like the best. You don't need to sacrifice chart quality with your dealer when so many great alternatives are available. Many traders also invest in a professional-grade charting platform, like Metastock Pro FX. Professional-grade charting platforms provide an independent feed for forex prices, access to the other financial markets (stocks, options, futures, etc.), and advanced analytical and back-testing tools.
Watch the video now:
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