Technical Analysis

Technical Analysis

Technical analysis is used for the prediction of market movements (that is alterations in

currencies prices, volumes and open interests) outgoing from the information obtained for the

past. The main instruments of technical analysis are different kinds of charts, which represent

currencies price change during a certain time preceding exchange deals, as well as technical

indicators. The latter are obtained as a result of the mathematical processing of averaging and

other characteristics of price movements. The instruments of technical analysis are universal and

applicable to any Forex sector, any currency and any time span.

Technical analysis is easy to compute what is important while the technical services are becoming

increasingly sophisticated and reasonably priced. They are available to all Forex participants

independent of their trade plans, strategies applied and the time of position continuance.

Dow Theory

The fundamental principles of technical analysis are based on the Dow Theory with the following

main thesis:

1. The price is a comprehensive reflection of all the market forces. At any given time, all

market information and forces are reflected in the currency prices (“The market knows

everything”).

2. Price movements are trend followers (“Trend is your friend”); trends are classified as

up trends (bullish), downtrends (bearish) and flat (sideways). Examples of mentioned

trends are given on Figures 4.1 – 4.3.

3. Price movements are historically repetitive (“The history repeats”) which results in the

same patterns periodically emerging on the charts.

4. The market has three trends: the longest (about 1 year) major, or primary, less

enduring (1 month and more) intermediate, or secondary, and rather short (several days

or weeks) minor. The primary trend has three phases: accumulation, run-up/run-down,

and distribution. In this way, in the accumulation phase of a bullish market the shrewdest

traders enter new positions. In the run-up/run-down phase, the majority of the market

finally "sees" the move and jumps on the bandwagon. Finally, in the distribution phase,

the keenest traders take their profits and close their positions while the general trading

interest slows down in an overshooting market. The secondary trend is a correction to the

primary trend and may retrace one-third, one-half or two-thirds from the primary trend.

In frame of a major trend may be any amount of secondary or minor trends. The structure

of a bullish trend is shown on Figure 4.5.

5. Trends exist until they are broken (See Figures 4.2, 4.3) and their reversals are

confirmed. Figure 4.4 shows examples of reversals in a bearish currency market. The

buying signals occur at points A and В when the currency exceeds the previous highs.

6. Volume must confirm the trend. Volume consists of the total amount of currency traded

within a period of time, usually one day. Large trading volume suggests that there is

interest and liquidity in a certain market and low volume warns the trader to close

positions. Open interest is the total exposure, or outstanding position, in a certain

instrument. Volume and open interest figures are available from different sources,

although one day late such as the newswires (Bridge Information Systems, Reuters,

Bloomberg), newspapers (the Wall Street Journal, the Journal of Commerce), weekly

printed charts ( Commodity Perspective, Commodity Trend Service).

Percentage measures of price reversals. The price of a foreign currency even on the strongest

trends is never moving constantly up or down. Traders watch possible reversals (a change in the

movement direction) at certain points of charts. There are three following typical points of a

possible reversal that can be marked on a chart in percents against the preceded movements

(percentage retrenchments):

1. Along Charles Dow a reversal up traditionally is occurring after the price has passed

down 1/3 (33%), ½ (50%) or 2/3 (66%) of the latest rise up. The reversal after 66% is

considered as a trend correction.

2. Using Fibonacci constants (See Chapter 5) one may wait for a reversal up at the

downtrend points at 0.382 (38%), 0.5 (50%) and 0.618 (62%) of the latest rise up.

3. Along Gann one has to wait for a reversal up after each 1/8 of the latest rise up on the

path down.

4.2. Charts for the technical analysis

Kinds of prices and time units. Charts for technical analysis are being constructed in coordinates,

“price (the vertical axis) – time (the horizontal axis)”. The following kinds of currency prices

represented on charts are being distinguished on Forex:

• open – a price at the beginning of a trade period (year, month, day, week, hour,

minute or a certain amount of one from these units);

• close - a price at the end of a trade period;

• high – the highest from prices observed during a trade period;

• low – the lowest from prices observed during a trade period.

Providing the technical analysis one uses charts for different time units – from 1 year or more

until 1 minute. For instance, the computer program Trading Intl. uses allows you to analyze price

movement charts for 1 day, 4 hours, 30 minutes, 15 minutes, 5 minutes and 1 minute. The longer

the time unit applied to plotting the chart, the longer the time span used to analyze price

movements and to determine the major trend by means of the chart. For short trading, charts for

smaller time units are more suitable.

Line chart. The line chart is plotted connecting single prices for a selected time period. The most

popular line chart is the daily chart. Although any point in the day can be plotted, most traders

focus on the closing price, which they perceive as the most important (see Figure 4.6). But an

immediate problem with the daily line chart is the fact that it is impossible to see the price activity

for the balance of the period as well as gaps (See chapter 4.6) – breakups in prices at joints of

trade periods. Nevertheless, line charts are easier to visualize. Also, technical analysis goes well

beyond chart formation; in order to execute certain models and techniques, line charts are better

suited than any of the other charts.

Bar chart. The bar chart consists from separate histograms (See figure 4.7). To plot a histogram

in coordinates price – time the points responding to high, low, open and close prices for a time

period analyzed should be marked on the one vertical bar. The opening price usually is marked

with a little horizontal line to the left of the bar; and the closing price is marked with a little

horizontal line to the right of the bar. Bar charts have the obvious advantage of displaying the

currency range for the period selected. An advantage of this chart is that, unlike line charts, the

bar chart is able to plot price gaps. Hence, it is impossible to see on a bar chart absolutely all price

movements during the period.

Candlestick chart. The candlestick chart is closely related to the bar chart. It also consists of four

major prices: high, low, open, and close (See Figure 4.8). In addition to the common readings, the

candlestick chart has a set of particular interpretations. The latter is possible thanks to the

convenient visual observation of that chart.

The opening and closing prices form the body (jittai) of the candlestick. To indicate that the

opening was lower than the closing, the body of the bar is left blank. Current standard electronic

displays allow you to keep it blank or select a color of your choice. If the currency closes below

its opening, the body is filled. In its original form, the body was colored black, but the electronic

displays allow you to keep it filled or to select a color of your choice. The intraday (or weekly)

direction on a candlestick chart can be traced by means of two "shadows": the upper shadow

(uwakage) and the lower shadow (shitakage). Just as with a bar chart, the candlestick chart is

unable to trace every price movement during a period's activity.

Continue: Trends, Support & Resistance Lines