How to apply technical analysis?
Technical analysis as a method of studying changes in the prices of financial tools to predict them in the future, appeared in the early twentieth century and was used for trading shares on the stock exchanges. It was based on the economic theory of Charles Henry Dow, who formulated the basic postulates that describe the behavior of the securities market in time:
- The price discounts everything. This concise statement indicates that any factors that affect the change in prices (Economics, politics, and even force majeure) are fully reflected in the price chart and do not require additional analytical tools to predict the behavior of prices, in addition to analyzing the prices;
- The price movement is not chaotic, but has a clear direction, which is likely to be stored for a long time. This postulate reflects the trending nature of the markets;
- Price history always repeats itself. The basis of this rule is based on the idea that the basis of all price changes in the market in human nature and psychology, that is, if in the past under certain conditions, the price behavior was in some expressly, that in the future it will happen again under similar circumstances.
Like any other theory, the tenets of Charles Dow is often criticized. Some even call it pseudo-science. However, the methods of technical analysis of financial markets, which are based on this theory for over 100 years successfully applied the largest financial institutions and most successful private traders throughout the world. Trade using technical analysis allows you to consistently and very accurately to solve the main problems that face every participant in the market.
The determination of the direction of the trend
The first and most important thing required for successful trading – the determination of the direction of the current trend, that is, tendencies of change of a currency pair at a given time interval. According to the rules of technical analysis, there are three types of trends:
- The ascendant is called the trend, in which prices of financial instrument grow for a long period of time, and this trend is confirmed by the fact that each maximum and minimum price is on the chart above the previous one, as shown in the figure below:
- Considered to be a downward trend when the change in the asset price occurs in such a way that on the chart there is a clear tendency of decline, and every subsequent minima and maxima are located below the previous one:
- A flat, or the phase of consolidation, when price fluctuations are very small, but the trend is visible on the chart as the alternation of successive maxima and minima, which are situated horizontally and oscillating near their equilibrium values
Depending on which direction is the current trend, traders decide to buy or to sell their assets, as trends tend to continue more often than to stop.
The duration of the trend
To evaluate trading opportunities and predict trading purposes, it is important to determine, using the methods of technical analysis, the duration of the current trend at the time. There are three main time intervals, within which develops price trend:
- Short-term trend, which usually lasts a few days;
- Medium-term trend, the duration of which is several weeks;
- The long-term trend, which is considered to be the primary trend lasts from several months to several years.
Depending on what style of trading a trader uses the trades are opened in the direction analyze the current trend, but always take into account the fact that the longest trend is the most likely scenario of price change in the future as this follows and the nature of the trends.
Fbasics development trend
Since trends tend to continue rather than stop, the trader is important to determine in what phase of development is the market trend in real time. Applying technical analysis methods and using the graphical construction of all the trends can be divided into three age groups:
- Young trends, which represent trends, the period of existence of which does not exceed 1/3 of their full life cycle. For the short-term is 1-2 days, the medium for 1-2 weeks, or 1-2 months for long-term trends. Such trends are called emerging, and trade in them can be very profitable, but carries significant risks;
- Mature trends assumed price trends, which are in the middle of its life cycle, depending on the total duration. Trade in the direction of such a Mature trend is most attractive and the safest, most traders trade only in the direction of Mature trends;
- Old, dying trends market trends that continue for a long time, coming to the end of the life cycle and largely has exhausted itself. Trade in direction of trend dying relatively safe, as even after the first hint of a change in trends, price will most likely be repeatedly to return to the original levels and will not produce a serious loss. But the dynamics of the old trends of low and expect big profits should not be.
Volatility as a characteristic of the trend
In addition to the direction, duration, and phase of the trend for profitable trading in the FOREX market it is necessary to consider the volatility of the market instrument, which is defined as the maximum amplitude of the price fluctuations of a financial instrument over the current trend. There are different ways of measuring and indicators of volatility, which all market-based instruments cant to be divided into three groups:
- The low-liquid instruments, the amplitude of price fluctuations within the day which doesn't exceed 1/3 of average daily range. Trade instruments with low variability of prices is possible only in the direction of the trend, it does not require large stop-loss levels, but the profitability of such operations, generally low;
- Tools with the normal volatility of the currency pair, the magnitude of price fluctuations within the day which is from 1/3 to 2/3 of the average daily range. Working with such tools in the direction of the main trend of the most attractive, provided that it is a Mature trend, preferably medium or long term;
- Higher volatility trading instruments is characterized in that the oscillation amplitude intraday price exceeds 2/3 the average daily range. The trade in such assets carries increased risk and requires special attention and experience.
Remember that volatility is not constant and can change in different phases of the trend and due to various external factors. Assessment of the variability of prices should correspond to the open time of the transaction and the date of achievement of planned objectives. The use of irrelevant data technical analysis can lead to serious losses.
Determining the point of entry into the market
The main task of technical analysis – identifying the entry points in the market, that is, the presence of such presumable level of prices on the chart trade which will entails minimal risk and can bring the most profit.
To determine entry point the trader need to figure out the main characteristics of the current trend, as mentioned above. Based on these data, depending on the strategy orders may open on the breakdown of a certain price level or "on the rebound" from him. Despite many variations, the basic method of search entry points are always based on these PRostich rules, as shown in the figure.