You will find below a breif description of the major technical analysis techniques used in Forex trading. We suggest you open free demo account and test them with no risk.
Bollinger Bands
Bollinger Bands are a technical trading tool created by John Bollinger in the early 1980s. They arose from the need for adaptive trading bands and the observation that volatility was dynamic, not static as was widely believed at the time.
The purpose of Bollinger Bands is to provide a relative definition of high and low. By definition prices are high at the upper band and low at the lower band. This definition can aid in rigorous pattern recognition and is useful in comparing price action to the action of indicators to arrive at systematic trading decisions.
Bollinger Bands consist of a set of three curves drawn in relation to securities prices. The middle band is a measure of the intermediate-term trend, usually a simple moving average, that serves as the base for the upper and lower bands. The interval between the upper and lower bands and the middle band is determined by volatility, typically the standard deviation of the same data that were used for the average. The default parameters, 20 periods and two standard deviations, may be adjusted to suit your purposes:
Middle Bollinger Band = 20-period simple moving average
Upper Bollinger Band = Middle Bollinger Band + 2 * 20-period standard deviation
Lower Bollinger Band = Middle Bollinger Band - 2 * 20-period standard deviation
Two important tools are derived from the Bollinger Bands: BandWidth, a relative measure of the width of the bands, and %b, a measure of where the last price is in relation to the bands.
BandWidth = (Upper Bollinger Band - Lower Bollinger Band) / Middle Bollinger Band %b = (Last - Lower Bollinger Band) / (Upper Bollinger Band - Lower Bollinger Band)
MACD - Moving Average Convergence Divergence
MACD is a more detailed method of using moving averages to find trading signals from price charts. Developed by Gerald Appel, the MACD plots the difference between a 26-day exponential moving average and a 12-day exponential moving average. A 9-day moving average is generally used as a trigger line, meaning when the MACD crosses below this trigger it is a bearish signal and when it crosses above it, it's a bullish signal.
As with other studies, traders will look to MACD studies to provide early signals or divergences between market prices and a technical indicator. If the MACD turns positive and makes higher lows while prices are still tanking, this could be a strong buy signal.
Conversely, if the MACD makes lower highs while prices are making new highs, this could be a strong bearish divergence and a sell signal.
One final word of advice: Don't get too caught up in the mathematics involved in putting together each study. It is much more important to understand how and why studies can and should be manipulated based on the time periods and sensitivities that you determine are ideal for the currency you are trading.
These ideal levels can only be determined after applying several different parameters to each study until the charts and studies begin to reveal the "details behind the details."
One final word of advice: Don't get too caught up in the mathematics involved in putting together each study. It is much more important to understand how and why studies can and should be manipulated based on the time periods and sensitivities that you determine are ideal for the currency you are trading.
These ideal levels can only be determined after applying several different parameters to each study until the charts and studies begin to reveal the "details behind the details."
Moving Averages
One of the most basic and widely used indicators in a technical analyst's tool box, moving averages help traders verify existing trends, identify emerging trends, and view overextended trends about to reverse. Moving averages are lines overlaid on a chart indicating long term price trends with short term fluctuations smoothed out. There are three basic types of moving averages:
Simple
Weighted
Exponential
Weighted
Exponential
A simple moving average gives equal weight to each price point over the specified period. The user defines whether the high, low, or close is used and these price points are added together and averaged. This average price point is then added to the existing string and a line is formed. With the addition of each new price point the sample set drops off the oldest point. The simple moving average is probably the most widely used moving average.
A weighted moving average gives more emphasis to the latest data. A weighted moving average multiplies each data point by a weighting factor which differs from day to day. These figures are added and divided by the sum of the weighting factors. A weighted moving average allows the user to successfully smooth out a curve while having the average more responsive to current price changes.
An exponential moving average is another way of "weighting" the more recent data. An exponential moving average multiplies a percentage of the most recent price by the previous period's average price. Defining the optimum moving average for a particular currency pair involves "curve fitting". Curve fitting is the process of selecting the right number of periods with the correct type of moving average to produce the results the user is trying to achieve. By trial and error, technicians work with the time periods to fit the price data.
Because the moving average is constantly changing based on the latest market data, many traders will use different "specified" time frames before they come up with a series of moving averages that are optimal for a particular currency.
For example, a trader might create a 5-day, a 15-day and a 30-day moving average for a currency and then plot them on his or her price chart. He might start out using simple moving averages and end up using weighted moving averages. In creating these moving averages, traders need to decide on the exact price data that will be used in this study; meaning closing prices vs. opening prices vs. high/low/close etc. After doing so, a series of lines are created that reflect the 5-day, 15-day and 30-day moving average of a currency.
Once the data is layered over a price chart, traders can determine how well these chosen periods keep track of the trend being followed. If, for example, a market is trending higher, you'd expect the 30-day moving average to be a very accurate trend line, providing a line of support for prices on their way higher. If prices seem too close under this 30-day moving average on several occasions without resulting in a halt in the up trend, a trader will simply adjust the time period to say a 45-day or 60-day moving average in order to optimize the average. In this way, the moving average will act as a trend line.
After determining the optimum moving average for a currency, this average price line can be used as a line of support in maintaining a long position or resistance in maintaining a short position. Breaches of this line can also be used as a signal that a currency is in the process of reversing course, in which case a trader will want to pare back an existing position or come up with entry levels for a new position. For example, if you determine that a 30-day moving average has shown itself to be a good support line for USD-JPY in an upward trending market, then market closes under this 30-day moving average line could be a signal that this trend could be running out of steam. However, it is important to wait for confirmation of these signals. One way to do this is to wait for another close below the level. On the second close under the average, you should begin to pare down your position. Another confirmation involves using other, shorter term moving averages.
While a longer term moving average can help to define and support a particular trend, shorter term moving averages can provide lead signals that a trend is ending before prices dip below your longer term moving average line. For this reason, most traders will plot several moving averages on the same chart. In a market that is trending higher, a shorter term moving average might signal a market reversal by turning down and crossing over the longer term moving average. For example, if you are using a 15-day and a 45-day moving average in a market that is in an up trend, and the 15-day moving average turns down and crosses over the 45-day moving average, this could be an early signal that the up trend is ending and it is probably time to begin to pare down your position.
For example, a trader might create a 5-day, a 15-day and a 30-day moving average for a currency and then plot them on his or her price chart. He might start out using simple moving averages and end up using weighted moving averages. In creating these moving averages, traders need to decide on the exact price data that will be used in this study; meaning closing prices vs. opening prices vs. high/low/close etc. After doing so, a series of lines are created that reflect the 5-day, 15-day and 30-day moving average of a currency.
Once the data is layered over a price chart, traders can determine how well these chosen periods keep track of the trend being followed. If, for example, a market is trending higher, you'd expect the 30-day moving average to be a very accurate trend line, providing a line of support for prices on their way higher. If prices seem too close under this 30-day moving average on several occasions without resulting in a halt in the up trend, a trader will simply adjust the time period to say a 45-day or 60-day moving average in order to optimize the average. In this way, the moving average will act as a trend line.
After determining the optimum moving average for a currency, this average price line can be used as a line of support in maintaining a long position or resistance in maintaining a short position. Breaches of this line can also be used as a signal that a currency is in the process of reversing course, in which case a trader will want to pare back an existing position or come up with entry levels for a new position. For example, if you determine that a 30-day moving average has shown itself to be a good support line for USD-JPY in an upward trending market, then market closes under this 30-day moving average line could be a signal that this trend could be running out of steam. However, it is important to wait for confirmation of these signals. One way to do this is to wait for another close below the level. On the second close under the average, you should begin to pare down your position. Another confirmation involves using other, shorter term moving averages.
While a longer term moving average can help to define and support a particular trend, shorter term moving averages can provide lead signals that a trend is ending before prices dip below your longer term moving average line. For this reason, most traders will plot several moving averages on the same chart. In a market that is trending higher, a shorter term moving average might signal a market reversal by turning down and crossing over the longer term moving average. For example, if you are using a 15-day and a 45-day moving average in a market that is in an up trend, and the 15-day moving average turns down and crosses over the 45-day moving average, this could be an early signal that the up trend is ending and it is probably time to begin to pare down your position.
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