Lesson #7: Technical Analysis: Or, How to Predict the Future by Studying the Past (even if the "past" was 15 minutes ago).
As you've probably guessed by now, the reason we touched upon TECHNICAL analysis in yesterday's lesson, but saved its DETAILED discussion for today (last, behind the discussion of FUNDAMENTAL analysis), is twofold:
#1) to ensure you know they're mutually-inclusive. The best traders don't discount one or the other but understand that having a grasp on how the fundamentals influence market sentiment gives him/her an edge over those traders who don't.
#2) to ensure you know that TECHNICAL analysis is the easiest and most precise way of trading the FOREX market.
Before we tell you more about technical analysis, understanding the philosophical assumptions on which technical analysis is based, and why it's ideally-suited for the FOREX market, would be a good start:
#1) "The number's don't lie" - all available information and its impact on traders, and the market, are already reflected in a currency's price.
#2) Prices move in trends - the foreign exchange market is mostly composed of trends and is, therefore, a place where technical analysis can be very effective.
#3) History repeats itself - over time, certain chart patterns become consistent, predictable and very reliable. The catch is SEEING them. There's always more than meets the eye at first glance.
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The Magic Bullet, the Holy Grail, the Secret Sauce:
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While we're not claiming that you'll become wealthy by diving deep and hard into FOREX technical analysis, techniques, methods, etc., we WILL go on the record and say that all wealthy FOREX traders DO perform technical analysis.
Why ?
Because, like us, they have unyielding B-E-L-I-E-F in one simple TRUTH:
*** PRICES MOVE IN TRENDS ***
The traders who don't believe this obviously have no need to implement a trading methodology on technical analysis. But, over 100 years of research has shown that those who trade "with the trend", more often than not, greatly improve their changes of winning (i.e., making a profitable trade).
Many times finding the prevailing trend will help you become aware of the overall market direction and offer you better visibility--especially when shorter-term movements tend to clutter the picture. And many times following the trend will bail you out of an initially less than great entry point.
So, how does technical analysis help you to determine what the trend is and HOW to trade *with it* versus against it?
Okay good question and, yes, we'll answer that, but before we do, let us first make sure you understand one very IMPORTANT POINT:
Even though, through our courses, we teach you how to use and read various technical indicators to identify a long-term trend, spot predictable chart patters and use certain rules to enter and exit a high-probability trade -- and even though all this involves sound logic, parameters, proven methods, processes, formulas, data, and research, these technical indicators, by themselves, are not the Holy Grail of FOREX trading. But, they're not some passing fad or hyped-up secret black box either. Beyond the mere rules, the human element is core to the strategy. It takes discipline and emotional control to stick with trading Following through the inevitable market ups and downs. Keep in mind though, good technical traders expect ups and downs. They are planned for in advance.
Okay, so now that you know that we're not claiming technical analysis is the Magic Bullet of trading (we often get asked, "Of the indicators you teach us how to use, which ones are better?" and we reply: NONE - technical indicators should simply be components of your overall customized / personalized trading system and not systems in and of themselves. They are like tools in a tool kit, not the kit itself!) let's talk about what technical analysis helps you look for:
The objectives - As a FOREX Technical Trader, your goals are:
#1) To figure out the price action of the currency pair. Price is the main concern. If the EUR/USD is at 1.3224 and goes to 1.3220, 1.3114, 1.3010 - the market is in a down trend. Despite what every technical indicator might predict, if the trend is down, stay with the trend. Indicators showing where price will go next or what it should be doing are useless. A trader need only be concerned with what the market is doing, not what the market might do. The price tells you what the market is doing.
#2) To always remember that technical indicators are only giving you confirmations based on what the market is telling you. So listen to the market and let it dictate which method you will use and which tool you will pull out of your bag of strategies and techniques. For only by listening to the markets will you ever be able to conquer it successfully!
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Indicators: Their Uses
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Here are just a few of the most popular indicators and their purposes as they relate to the Currency Markets.
<<< Moving Averages >>>
If you believe in the "trend-in-your-friend" tenet of technical analysis, moving averages are very helpful. Moving averages tell the average price in a given point of time over a defined period of time. They are called moving because they reflect the latest average, while adhering to the same time measure.
A weakness of moving averages is that they lag the market, so they do not necessarily signal a change in trends. To address this issue, using a shorter period, such as 5 or 10 day moving average, would be more reflective of the recent price action than the 40 or 200-day moving averages.
Alternatively, moving averages may be used by combining two averages of distinct time- frames. Whether using 5 and 20-day MA, or 40 and 200-day MA, buy signals are usually detected when the shorter-term average crosses above the longer-term average. Conversely, sell signals are suggested when the shorter average falls below the longer one.
There are three kinds of mathematically distinct moving averages: Simple MA; Linearly Weighted MA; and Exponentially Smoothed. The latter choice is the preferred one because it assigns greater weight for the most recent data, and considers data in the entire life of the instrument.
<<< 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.
<<< Bollinger Bands >>>
The basic interpretation of Bollinger Bands is that prices tend to stay within the upper and lower bands. The distinctive characteristic of Bollinger Bands is that the spacing between the bands varies based on the volatility of the prices. During periods of extreme currency price changes (i.e., high volatility), the bands widen to become more forgiving. During periods of low volatility, the bands narrow to contain currency prices. The bands are plotted two standard deviations above and below a simple moving average. They indicate a "sell" when above the moving average (or close to the upper band) and a "buy" when below it (or close to the lower band). The bands are used by some Forex traders in conjunction with other analyses, including RSI, MACD, CCI, and Rate of Change.
<<< Fibonacci Retracements >>>
Fibonacci retracement levels are a sequence of numbers discovered by the noted mathematician Leonardo da Pisa during the twelfth century. These numbers describe cycles found throughout nature and when applied to technical analysis can be used to find pullbacks in the currency market.
Fibonacci retracement involves anticipating changes in trends as prices near the lines created by the Fibonacci studies. After a significant price move (either up or down), prices will often retrace a significant portion (if not all) of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retracement levels.
In the currency markets, the commonly used sequence of ratios is 23.6 %, 38.2%, 50% and 61.8%. Fibonacci retracement levels can easily be displayed by connecting a trend line from a perceived high point to a perceived low point. By taking the difference between the high and low, the user can apply the % ratios to achieve the desired pullbacks.
<<< RSI >>>
RSI stands for Relative Strength Index. The RSI measures the markets activity as to whether it is over bought or over sold. It gives a trader an indication as to which way the Market is moving. It is important to note, that this is a leading indicator and thus allows one to see what the market is ABOUT to do and then act accordingly. The higher the RSI number, the more over bought it is and conversely the lower the RSI number, the more over sold it is. It is a great leading indicator for the micro and macro reversals in the market. By using an RSI on the 1-minute chart set at a period of 18 and overlaid on the bottom of your charts tend to give the best entry signals. This can also be applied to the 5-minute chart as well. The two significant entry numbers are 25 and 75.
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Technical Traders use some of these indicators, all of them, or a combination of them (our course packages tell you HOW we use various indicators to trade successfully) to confirm that they really do have a high-probability trade signal. A consistently winning FOREX trader will use 3 or 4 indicators to provide a DEFINITIVE signal to get in a trade.
Always remember: missed money is always better than lost money !
The GOLDEN RULE is this: Technical trading should be primarily systematic with a touch of "gut check" (see Ed Seykota's interview excerpt from yesterday's lesson).
Price and time are pivotal at all times. Technical methods are not based on an analysis of fundamental supply or demand factors, political news, or a countries economic profile.
Rather, to our pleasure, Technical Trading, gives us a good handle on how to answer these critical questions:
- How and when to enter the market.
- How many lots to trade at any time.
- How much money to risk on each trade.
- How to exit the trade if it becomes unprofitable.
- How to exit the trade if it becomes profitable.
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Stay Tuned for tomorrow's email from us. It will have the following Subject line:
Lesson 8 - The Rapid Forex e-Course
Learn why "a rising tide raises all ships" and why The Trend, yes, truly wants to be your friend. |
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