Forex Investment and Currency Trading

Understanding and Reading Charts

Charts used for technical analysis in Forex trading are like a road map to the historical price movement of a currency. If you took statistics when you were in college, these charts would be known as times series plots.

On the y-axis (vertical axis), you will find the price scale and on the x-axis (horizontal axis), you will find the time scale. Historical prices for the currency are plotted from left to right across the x-axis, with the most recent price shown on the point furthest to the right.

You can pick the time periods you want shown on the chart. If The chart was set up in one-hour price points, that means each point on the chart represents one hour of trading. Your charting software, which is included with most trading packages, can be set with many different intervals.

When you set the time periods, it compresses the data. A tick chart would be the least compressed and a monthly chart would be the most compressed. For example, you may want to see the data intraday, daily, weekly, or monthly. The less compressed the data, the more detail you will see.

A tick chart will change whenever the price changes, which often occurs in less than a minute.

When you pick an interval, the points shown on the table will represent price points during that trading interval. Intervals included on most currency charting software include tick, 1-minute, 5-minute, 10-minute, 15-minute, 20-minute, 25-minute, 30-minute, 35-minute, 40-minute, 45-minute, 50-minute, 55-minute, 1-hour, 2-hour, 4-hour, daily, weekly and monthly.

Currency traders usually concentrate on charts that show intraday data to forecast short-term price movements. Remember the shorter the time frame, the less compressed the data will be. That’s when you can see the most detail.

But short-term charts can be volatile and contain a lot of noise, such as sudden price movements and wide high-low ranges, which can distort the overall picture. Try out different time periods to see how different the picture will be, depending on the time frame you choose. One-hour time periods are the most commonly used by Forex traders to pick up intraday trends.

Line Chart

The simplest type of chart called a line chart. This chart is created by plotting one price point of a currency over a specified period of time. The line is made by connecting the dots of each of these plotted points.

Bar Chart

The most popular charting method used by traders is the bar chart. This shows the highs and lows for the currency during the time period selected. Each bar on the chart represents one time period.

Bar charts display a large amount of data. The addition of the high-low range for each time period helps you to recognize the movement between the time periods and more easily pick up the trends. The little lines inside the high-low bar show the opening and closing price for the time period.

Candlestick Chart

Candlestick charts, which originated in Japan over 300 years ago, are regaining popularity among traders. In these charts, instead of just bar lines representing the time periods, you’ll see a little box form. The top of the box is the opening price for the period and the bottom of the box is the closing price on a down candle. The opposite is true for an up candle.

On most candlesticks, you’ll also see a line above and below the box. The line above the box shows you the high during the period and the line below the box shows you the low.

Candlestick charts show more detail using small boxes to indicate the open and close price for the period. The line above the box shows the high price for the period and the line below the box shows the low price.

Many traders find the candlestick charts easier to read, especially when you’re trying to judge the relationship between the open and close price. Note that there is a lighter-colored box when the close is higher than the open and a darker-colored box when the close is lower than the open. Officially, the box formed to show the open and close is called the body. The lines to show the high and low above and below the body are called shadows.

Spotting Trends

You’re probably wondering what exactly you’re trying to find in all these squiggly lines. You’re looking for a trend or a specific pattern for the price movement to attempt to figure out where the price is going and pick good buy and sell points for the currency.

Basically what you can see in these charts is a picture of the psychology of buyers and sellers by looking at the historical price movements. When prices are moving upward, buyers are more interested in buying and sellers are less interested in selling. Conversely, when prices are falling, sellers are more interested in selling to get out before they lose their gains, while buyers are more interested in buying with the hope they can get in at the right price to make a profit on the next upward movement.

Drawing Trend Lines
The first thing you must do is draw a trend line. All you need to do to draw the line is connect two high swings (or peaks) and two low swings (or troughs).

As you can see, when you draw a trend line, it’s like connecting the dots. You find two points and draw a line between them.

As a trader, what you want to do is predict which way the dollar is going based on the price history you see in the chart. You determine the trend, upward or downward, and develop a plan to figure out at what point you want to buy and at what point you want to sell the pair.

Support and Resistance Levels

As you try to make the determination of when to buy or sell a currency, look for signs of support and resistance.

• Support is a price point below the current market price where buying occurs. It is always the lower trading range boundary. When the price drops to the support level, buyers start to buy because they think the price will rise from this level.
• Resistance is a price point above the current market price at which sellers decide to sell. It is always the upper trading range boundary. When a currency pair hits the resistance point, buyers are losing interest in buying because the price is too high and sellers must lower their price in order to find buyers.

When reading the chart, you can see a number of times when the resistance point was reached and the price for the pair started to head downward. When the pair reached a high price, it started to drop in value. At that point buyers resisted the price and sellers had to start dropping the price to sell.

When the pair reached a low and it proved to be a support point, the buyers started buying to stop the price from falling any lower.

You determine these support and resistance points visually by reading your chart. But don’t think of charting as an exact science. While talking about price points as specific numbers to help people learn to read these charts, it’s better to think of zones of support and resistance, which translates into buying and selling ranges. Forex traders will see a lot of trading activity around these price points.

What you’re trying to locate when you follow trend lines is a breakout point—that’s the point when a currency pair drops out of the trading range and heads in the opposite direction.

The ups and downs of the market are smoothed out when you look at a longer time frame, so it’s easier to see the patterns when you have less detail. You get more detail and the most amount of noise from charts in the shorter time frames, such as 5- or 10-minute charts.

Types of Price Patterns

As you get more experienced working with charting, you’ll see that markets follow certain patterns. These patterns become very well known to traders. We review the basics of some of the better-known patterns, but no pattern guarantees you a perfect reading of the future trend for the market.

A well-known phrase among traders is, “the trend is your friend until it ends.” When you see a strong trend, try to research the fundamentals behind that trend and you’ll have an even better idea of what may be driving that trend and what the next moves for that currency pair might be.

Wedges

The wedge pattern forms when your trend lines look a lot like a symmetrical triangle. You’ll see that the trend lines you draw have highs and lows that come together at an angle. Usually this angle points up or down. Then you’ll see a trend, either up or down, form outside this pattern. An upward line would be a bullish trend indicating a good time to buy. A downward line would be a bearish trend indicating a good time to sell.

Channels

When you see your trend lines run almost flat with no indication of an upward or downward trend, then what you are seeing is called a channel. This type of pattern indicates that both buyers and sellers are undecided about the direction of the market. When you see this type of pattern, your best bet is to wait until you see signs of a breakout of the market in one direction or the other before picking your buy and sell points.

A price gap usually forms when the opening price of the current bar is above or below the closing price of the bar for the previous period. You’ll see gaps most often on daily charts. Frequently a gap can be an indication of a more dramatic breakout.

There are many other types of patterns traders use to determine their buying and selling strategies.

The keys to successfully working with charts are dedication, focus, and consistency:

• Dedication: You must decide you want to take the time to learn the basics of chart analysis and then apply this knowledge on a regular basis so you can continue to develop your skills.
• Focus: Once you have a good idea of which types of charts and patterns you like to use, concentrate on learning how to use them very well. Use a demonstration account with your Forex dealer to test out your charting skills for picking the best buy and sell points.
• Consistency: Be sure that you maintain your charts regularly. Preparing them daily even if you don’t plan to trade that day will help you develop strong and consistent trading strategies. This daily routine will enable you to quickly recognize patterns and make good trading decisions.