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Technical Analysis

Technical analysis is the method of evaluating traded products by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts believe that the price contains all known information and therefore technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.

With wonderful sounding names such as Elliot Wave Theory, Candlestick Charts, Moving Average Convergence Divergence or Bollinger Bands they all have the common aspect of presenting us with a visual approach to market analysis.

In the section we introduce you to a handful of methods that are currently applied to the market.

Support and resistance

Support is the price level at which demand is thought to be strong enough to prevent prices from declining further. Support levels are below the current price, though it is not uncommon for prices to dip below support briefly signaling a false breakout. With a support level broken, the market will move lower indicating that the sellers have overwhelmed the buyers. Once a support level has been broken, another support level will be established at a lower level and the tendency is that support level that was breached, will now become a resistance level.

Resistance is the price level at which demand is thought to be strong enough to prevent prices from rising further. Resistance levels are usually above the current price. A clear break above the resistance level signals that the buyers are in control. In this instance there are fewer sellers and the price tendency is to move further up. Once a resistance level has been broken, another resistance level will be established at a higher level and as with the support level, when the resistance level is breached, this will now become the new support level.

Moving Averages

Moving averages are very popular tools used by technical traders to measure momentum. They are usually the first tool that technical analysts are introduced to as they are simple to apply and are building blocks to more complicated moving average theories. The main purpose of these averages is to smooth price data so traders can be in a better position to gauge the likelihood that a current trend will continue. Moving averages are commonly used to predict areas of support and resistance and are also used in conjunction with other indicators to help give more accurate entry and exit signals. There are different types of averages that vary in popularity but, regardless of how they are calculated, they are all interpreted in the same manner.

We have simple moving averages, weighted moving averages and exponential moving averages.

A very simple theory is the moving average crossover. This is where you combine two moving averages with differing time frames. Where they cross will indicate the entry and exit points to a trader.

Fundamental Analysis

Fundamental analysis is the study of the core underlying elements that influence and impact on the underlying price of a security or a country’s economic well being. This method of study attempts to predict price action and market trends by analyzing economic indicators, government policy and other factors. Whilst fundamental analysis may help you forecast an underlying real value for a stock or share, when it comes to fundamental analysis for the foreign exchange markets, the analysis is carried out to forecast economic conditions and underlying direction. Therefore for the currency markets, fundamental analysis is not an exact science to predict price. For example, you might get a clear understanding of the health an economy by studying an economist’s forecast of an upcoming economic release but that will not give you entry and exit points, simply price direction.

Fundamental analysis and the resulting figures will involve interest rates, central bank policy, political figures or events, employment reports; whether seasonal or unemployment figures, gross domestic product (GDP), etc. These economic indicators are snippets of financial and economic data published by various agencies of the government or private sectors for each country. These statistics, which are made public on a regularly scheduled basis, help traders monitor the health of the economy.

Fundamental analysts broadly label economic data and news releases into three categories. The release is either there to reflect the current state of the economy which is referred to as a coincident indicator, is alternatively known as a leading indicator as the release will look to predict future conditions or is finally known as a lagging indicator.

The Majors

Most currency transactions involve the ‘Majors’, consisting of the British Pound (GBP), Euro (EUR), Japanese Yen (JPY), Swiss Franc (CHF) and the US Dollar (USD). Whilst these are the key five currencies, the Canadian Dollar (CAD) and the Australian Dollar (AUD) are starting to be considered as additional ‘major’ currencies.

Currencies in Pairs

The logic for currency pairing, is that if we had a single currency alone, we would have no means to measure its relative value. By pairing two currencies against each other a fluctuating value can be established for one versus the other.

Currency Pairs that do not include the US dollar are commonly referred to as Cross Currency Pairs. Cross Currency trading can open a completely new aspect of the Forex market to speculators. Some cross currencies move very slowly and trend very well. Other cross currency pairs move very quickly and are extremely volatile with daily average movements exceeding 100 pips

The SWAP

When we execute a Forex transaction, we essentially borrow one currency and lend another. This borrowing and lending is like any other banking transaction and therefore subject to interest rates. The interest is referred to as the SWAP rate in the currency markets. The Swap is a credit or debit as a result of daily interest rates. When traders hold positions overnight, they are either credited or debited interest based on the rates at the time.

The Spread

Forex prices are displayed in the form of a Bid/Ask spread. The spread is the difference between the Bid and the Ask. The Bid and Ask serve as the prices that similar to other financial products. The Bid is the price at which a trader is able to sell a currency pair. The Bid price or sell price of a currency pair is always the lower price in a quote. The Ask, also sometimes referred to as the ‘Offer’, is the price at which traders are able to buy a currency pair.

The difference between the Bid and Ask is called the “Spread” and is effectively the cost of trade. There are typically no additional broker commissions involved in trading the Forex market, although we are witnessing a move towards commission based trading due to market execution.

Pips

Market increments are measured in ‘Percentage in Point’ or Pips for short. A pip is the 4th digit in the value of a currency pair (if you are trading from a 5 digit price feed); EURUSD 1.10872, GBPUSD 1.28653 etc. All Forex currency pairs, except for the Japanese Yen, measure the pip from the 4th decimal place, while the JPY and HUF currency pairs is on the 2nd decimal.

Price Quotes: What do they mean?

Reading a Forex quote may seem a bit confusing at first. However, it’s really quite simple if you are able to remember two things:

• The first currency listed is the base currency
• The value of the base currency is always 1 (one)

A quote of GBP at 1.28653 is to say that 1 Sterling Pound (GBP) = 1.28653 US Dollar (US). When the Sterling Pound is the base unit and a currency pair’s price increases, comparatively the Sterling Pound has appreciated and the other currency in the pair (usually known as the quote currency) has weakened. Using the above GBPUSD example as a reference, if the GBPUSD increases, from 1.28653 to 1.29653 (100 pips or 1000 points), the GBP is stronger because it will now buy more USD than before.

There are four currency pairs involving the US dollar in which the US dollar is not the base currency. Some exceptions are the Australian dollar (AUD), the British Pound (GBP), the Euro (EUR), the New Zealand dollar (NZD) etc. A quote on the GBPUSD of 1.28765 would mean that one British Pound is equal to 1.28765 US dollars. If the price of a currency pair increases the value of the base currency in comparison to the quote currency thus increases. Conversely, if the price of a currency pair decreases, such is to say that the value of the base currency in comparison to quote currency has weakened.

What Influences Price?

Forex markets and prices are mainly influenced by international trade and investment flows. It is also influenced, but to a lesser extent, by the same factors that influence the equity and bond markets: economic and political conditions, especially interest rates, inflation, and political stability, or as is often the case, political instability. Though economic factors do have long term effects, it is often the immediate reaction that causes daily price volatility, which makes Forex trading very attractive to intra-day traders.

Currency trading can offer investors another layer of diversification. Trading currencies can be viewed as a means to protect against adverse movements in the equity and bond markets, movements that of course also impact mutual funds. You should bear in mind that trading in the off-exchange foreign currency market is one of the riskiest forms of trading and you should only invest a small portion of your risk capital in this market.

Private investors or individuals are often referred to as Retail Forex Traders. Retail Forex traders, or speculators, commonly access the off-exchange retail foreign currency market (or Forex market) via a Forex broker. They do not trade in the actual Interbank market itself. Typically this includes specific Forex trading software developed for the Retail Forex Market – such as MetaTrader 4 (a MetaQuotes product) or trading platforms that have been developed in-house for use on the internet.

The brokers act as a bridge between you and their liquidity partner or partners (sometimes larger global banks) that you would otherwise not have sufficient capital to do business with. This can happen in one of several ways. Whilst some Forex Brokers act as market makers, meaning that they create the liquidity and assume some risk, other retail brokers clear trades directly through to the larger banks that provide their liquidity. The latter is referred to as straight through processing.

Forex Market Hours

Unlike other financial markets, the Forex market operates 24 hours a day, 5 days a week. Starting in Sydney, then Tokyo followed by Europe and finally the Americas, the market opens late on Sunday evening and then closes late on Friday. It is conducted through an electronic network of banks, corporations and individual traders exchanging currencies. For retail traders Forex is primarily used as a means for speculative investing and actual physical delivery of currencies is almost never intended.

In the early part, the Forex market was used by institutional investors that transacted large amounts for commercial and investment purposes. Today however, importers and exporters, international portfolio managers, multinational corporations, speculators, day traders, long term holders and hedge funds all use the Forex market to pay for goods and services, transact in financial assets and speculate or to reduce the risk of currency movements by hedging their exposure or increasing their exposure through speculation.

In today’s information superhighway the Forex market is no longer solely for the institutional investor. The last 10 years have seen an increase in non-institutional traders accessing the Forex market and the benefits it offers. Trading platforms such as MetaQuotes MetaTrader have been developed specifically for the private investor and educational material has become more readily available. These have all added to the attractiveness of the Forex market for the private investor.
 

The growth in the Forex market over the last decade has led to a number of advantages for the private investor. Trading material to educate the trader has become far more readily available. Support services via forums have become increasingly popular and in the event that you the private investor no longer wish to trade the account yourself, you have professional money managers that will take-over via managed accounts. In brief the main advantages for the private investor and the shorter term trader are:

24 hour trading, 5 days a week with 24 hour cover provided by the broker.

• HotForex provides 24 hour cover for its clients
• Cover from Sunday night through to Friday night.

An enormous liquid market.

• $3.6 trillion traded daily

Market volatility.

•  The Forex market is constantly moving providing volatility. It is this volatility that provides both long and short term traders the opportunity to profit from the Forex market.

Products that are traded

• With over twenty products being offered there are always opportunities in the market.

The ability to go long or sell short.

• You are not restricted to long positions only. If you believe that a currency pair is going down you have the ability to take a short position.

Low margin requirements.

•  With the low margin requirement you are able to leverage your account up to 1000.

The foreign exchange or ‘Forex Market’ is the world’s largest financial market. It is a non-stop cash market where currencies of nations are traded off-exchange through brokers.

It is estimated that, on average, $3.6 trillion is traded each day in the world Forex markets. The vast majority of Forex trading does not occur on any one centralized or organized exchange but through brokers on the interbank currency market. The interbank currency market is a twenty four hour market that follows the sun around the world. Opening in Australia and closing in the U.S. Whilst the market exists for organizations with exchange risk, speculators also participate in the Forex markets in an effort to profit from their expectations regarding shifts in exchange rates.