Forex Investment and Currency Trading

Technical traders have found a home in Forex. Some speculate that because of market efficacies and number of participants trading the major currencies, currencies move in very technical patterns. In addition, in a market where trades can last less than a minute, fundamentals might not give a trader the edge. Therefore those who understand these patterns will have an advantage.

Determining the Trend

The first task in technical trading is to determine the overall pattern of the market’s broader movements – its trend. Although the market might appear to be zigzagging, its true movement will be revealed. A trend can be established for various amounts of time – for minutes or for years.

Apart form uptrends and downtrends, a market can settle into a consolidation pattern, which essentially means that it isn’t going firmly in one direction or the other. In all cases, the market creates points of support and resistance. Often the market settles into familiar patterns.

Support and Resistance

Support is a price point below the current market price, where buying occurs to create a reversal to the downward trend. Resistance is a price point above the market price where selling pressure reverses the upward trend. Support has more buyers, and resistance has more sellers. Forex traders will find a lot of activity around these price points.

The trend and support and resistance are the most important technical indicators. They have moved away from just an illustration of historic price action into the realm of behavior finance, meaning a reflection of the trading habits of individual traders and market psyche en mass.

Chart patterns

One of the most famous technical patterns is called head and shoulders. It happens when the market rises, then falls an equal amount, then rises again much higher than before, then falls again an equal amount, then rises and falls again in a shape almost the same as the first rise. On a graph, it looks like a small hill (the left shoulder), a large hill (the head), and a small hill again (the right shoulder).

Sometimes the triangle pattern favors the uptrend or downtrend, in which case it can become a descending or ascending right-angle triangle. In the descending triangle, the line drawn between the trough is flat rather than rising, which indicates that the declines are deeper than the gains.

Why does this happen? When the price drops, buyers sense that it is oversold. They enter the market, pushing the price back up. Sellers see the gain and take profits, pushing the shares back down. The price falls, buyers reenter the market, and sellers sell again. The overall volume favors the sellers, and the price trends downward. Finally, the buyers decide that the price is unjustified, and they sell as well, causing the price to fall through the floor. This indicates that the market is in a bearish phase. In  a bullish phase, the trend is the opposite, with the breakout being through the point of resistance.

The wedge pattern is similar to the symmetrical triangle. The trend lines of the highs and lows come together as an angle. Usually, this angle points up or down, showing whether the market is in a bullish or bearish trend.

The channel patter is marked by indecision but usually does not buck the larger trend. The lines form peak to peak and trough to trough generally run flat on light volume.

The flags and pennants pattern is also a period of indecision, usually right after a big move in the currency. More often than not, the currency basically pauses at a flags and pennants pattern and then resumes whatever direction it was going before. The trend lines for the peaks and troughs run parallel.

An alternative to the standard price charting styles is the candlestick chart, which was developed by the Japanese in the 1700s to chart rice trading. Just like a standard bar chart, it shows the highs, lows, open, and close over a designated period of time. It uses a solid or empty body to illustrate whether the time frame is up or down. If nothing else, the effect is dramatic and illuminating. This kind of chart has many patterns, with intriguing names such as dark cloud cover, Gravestone doji, and three black crows. Although the validity of the patterns’ predictive ability is questionable, one thing is for sure: A trader needs to be able to control his or her emotions. The chart effect can panic undisciplined traders.

Fibonacci Pattern

In the eleventh century, an Italian mathematician named Leonardo Fibonacci noticed a pattern resulted when he added a series of consecutive numbers:

1 + 2 = 3
2 + 3 = 5
3 + 5 = 8
5 + 8 = 13
8 + 13 = 21

Each number in the sequence – 3,5,8,13,21 – results in the next number when it is multiplied by 1.618. This ratio appears in patterns across nature – from the structure of honeybee cells to musical notes – and has been called the Golden Ratio. Traders use Fibonacci’s number to determine retracement form a current price. Important retracement levels are 38.2 percent, 50 percent, and 61.8 percent.

Elliot Wave Theory

This is a complex theory that predicts future price movement through the study of wave patterns. The critical aspect of this theory is its determination of the individual wave’s relativity to the greater wave structure. There are two major types of waves: those that move with the trend, called impulse waves, and those that move against the trend, called corrective waves. Impulse and corrective waves can be dissected further. This theory relies on the fact that waves move in patterns. As soon as you have identified the wave classification, you can predict the next price movement.

Andrews Pitchfork

This is a derivative of the classic support and resistance theory. It consists of three parallel lines (points you select) that follow the trend. After you have picked your three points, this theory functions much like support and resistance. The key is picking the right points. Traders generally choose a major peak or trough and then two other points along the chart to create support or resistance. The middle line of the pitchfork is drawn from the selected peak to the midpoint of the other points and is drawn parallel and at the same angle.