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Technical Analysis

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Technical Analysis

While fundamental analysis focuses on what is happening in the real world, including economic, political, and business news and events, technical analysis largely focuses on what is happening in trading charts.

Trading charts simply chronicle the price movements of different trading instruments over time, which allows traders to identify patterns in price movements and make trading decisions based on the assumption that these patterns will repeat in the future. For example, one trading chart format is the Japanese candlestick chart, which is formatted to emphasise high and low price points for certain time increments (these increments can be set by the trader in their trading platform).

The trader can then see:

  • The opening price for the period
  • The highest price point for the period
  • The lowest price point for the period
  • The closing price for the period

This information can then allow traders to make judgements regarding a currency pair's price movement. For example, if a Japanese candlestick closes near the highest price for the period, that would imply that there is a strong interest on the part of buyers for this currency pair during that time period. A trader might then decide to open a long trade to take advantage of that interest.

Over time, common patterns emerge in the movement of the charts (and the formation of different candlesticks), which can then be used to predict potential future price movements and make the best trades based on these predictions. You can learn more about trading with Japanese candlesticks in these articles:

How to Read Candlestick Charts

Once a pattern emerges, this is known as a Forex indicator because it indicates that there is the potential to make a profitable trade. While there are a range of resources available online for learning about the best Forex indicators, your trading software should ideally have a range of built-in indicators that you can use for your trading, as is the case with MetaTrader 5's indicators. You can learn more about technical analysis in our Introduction to Technical Analysis article.

Wave Analysis

Wave analysis, also known as Elliott Wave analysis, is a well-known method that analyses the price chart for patterns and the direction (trend) of a financial instrument. The method is based on historical movements in market prices, with the belief that history repeats itself. The reason for this is due to market sentiment, meaning that the market as a whole moves as a herd, and reacts in a similar way to similar events and announcements.

In the Forex market, these reactions involve buying and selling currencies, which causes the prices of different currency pairs to fluctuate.

The theory follows sequences of five waves, or five up and down price movements which are then countered by a corrective 3 wave pattern in the opposite direction. The 5 impulsive waves are with the trend, whereas the 3 corrective waves are counter trend. In an 'up' move, there will be three up waves (movements 1, 3 and 5) and two down waves (movements 2 and 4).

In a corrective down move, there will be 2 waves down (A and C) and 1 wave up (B). In a down move, the instrument will make 3 waves down which are separated by 2 waves up. The corrective up wave will have 2 waves up and 1 wave down. Following this, the instrument will make a 'down' move, with three down waves being separated by two up waves.

While this pattern does not take place every time prices move, traders can use this method as a guideline for whether or not to enter into or exit a trade by taking the following steps:

Determine how you will generate the Elliott Wave count, keeping in mind that the approach must be consistent for all 'up' and 'down' movements.

Wait for a wave to begin. In many cases it is wise to wait until the end of the third or the beginning of the fourth movement in the wave, to ensure that the instrument is following the Elliott Wave price pattern.

Use a secondary indicator (or indicators) to confirm the trend.

Once you have taken these steps, you can enter into a trade with more confidence. If you would like to learn more about wave analysis, please read our Introduction to Forex Elliott Wave Analysis article.

6 Popular Forex Strategies

Now you know the what, the why, and the how of Forex trading. The next step to to create a trading strategy. For beginner traders, the ideal scenario is to follow a simple and effective strategy, which will allow you to confirm what works and what doesn't work, without too many variables confusing things. Fortunately, banks, corporations, investors, and speculators have all been trading the markets for decades, which means there is already a wide range of Forex trading strategies to choose from. These include:

  • Forex scalping: Scalping is a trading strategy that involves buying and selling currency pairs in very short increments - usually anywhere between a few seconds and a few hours. This is a very hands-on strategy that involves making a large number of small profits until those profits add up.

  • Intraday trading: Forex intraday trading is a more conservative approach than scalping, with trades focusing on daily price trends. Trades may be open anywhere between one to four days, but usually focus on the major sessions for each Forex market.

  • Swing trading: Swing trading is a medium-term trading approach that focuses on larger price movements than scalping or intraday trading. This means that traders can set up a trade and check in on it within a few hours, or a few days, rather than having to constantly sit in front of their trading platform, making it a good option for people trading alongside a day job.

  • Forex hedging: Hedging is a risk management technique where a trader can offset potential losses by taking opposite positions in the market. In Forex, this can be done by taking two opposite positions on the same currency pair (e.g. by opening a long trade and a short trade on the GBP/USD currency pair), or by taking opposite positions on two correlated currencies.

  • The Forex martingale strategy: The martingale strategy is a trading strategy whereby, for every losing trade, you double the investment made in future trades in order to recover your losses, as soon as you make a successful trade. For instance, if you invest 1 EUR on your first trade and lose, on the next trade you would invest 2 EUR, then 4 EUR , then 8 EUR and so on. Please note that this strategy is extremely risky by nature and not suitable for beginners!

  • The Forex grid strategy: The grid strategy is one that uses buy stop orders and sell stop orders to profit on natural market movements. These orders are usually placed at 10 pip intervals and, by having these stop orders put in place, a trader can then automate this trading strategy.

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