3. Strategies
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How to trading forex Fortfs page 3
PART 3: TECHNICAL ANALYSIS
How do you display pending orders?
Before we start dealing with technical analysis, we want to tell you about one more important thing – order types. Actually when you analyze the market situation, you inevitably make predictions where the price will be in the near future. After you make your prediction, you'll probably want to open a deal right away and then, a little later, when the price will reach its top and start to move the other direction, it will be the ideal time to close your open positio! But, you don’t have to sit at your Terminal and wait for the price to reach your pre-decided level to open a transaction like this. You can simply program a “pending order” for that price level, i.e. an order to your broker to open a transaction, which is deferred in time. Here are a few examples.
Let's say you have analyzed the market situation and are predicting that the price will still fall a bit more, down to a level of 1.3145, then turn around and start going up.
So, it makes sense for you to wait to open your transaction until the price is lowest. To do this, open a "new order" and then in the "Type" field select "pending order." Because you want to buy at a price that is below the current one, this type of order is called a Buy Limit (or limit-order to buy). Next, choose at which price you want your transaction to open (i.e., when the order should be fulfilled). In our case we should enter 1.3145. Next, choose the volume with which you want to enter the market and also be sure to set your stop loss and take profit levels. Additionally, you can set the expiration date of the order.
If the transaction does not open before that date then we, as your broker, will simply delete it.
Here’s another example: Let’s say the price is currently rising, but you have analyzed its movement and are confident that it will reach 1.4410 and then immediately turn downwards. That would be the perfect time to open a sell transaction!
In this case, your pending order is called a Sell Limit, i.e., your selling transaction will be opened at a price above the current one. You set up this type of order in the same way as you would a Buy Limit.
One last example: Let’s say it’s not clear in which direction the price will go from the current level of 1.3184 and no available indicators can offer any hints. Then you decide: If the price rises by 10 points and reaches 1.3195, that will mean that it will continue to grow and that would be a good time to open a buy transaction (Buy Stop - buy above the current price). Furthermore, if the price goes down by the same ten points, then it will likely continue to go down, and it’s a good time to open s sell transaction (Sell Stop - sell below the current price).
These orders are created the same way as the previous ones. And one more very important thing: any order to buy, even a pending order, will be opened at the Ask price and closed at the Bid price. Any order to sell is opened at the Bid price and closed at the Ask price.
Now since you understand the different types of orders, we can proceed directly to the subject of technical analysis.
What is technical analysis?
Technical analysis involves studying the historical movement of a price and predicting where it will go in the future. You do this on the basis of those charts that you see in the Terminal. Right now, if you look at the chart for the EURUSD currency pair, you can say whether the price of this instrument is rising or falling. If you scroll back, you can see how the price behaved last month or even last year. You may be confused why you need to care what price was that long ago, but in practice, you will find that history repeats itself. Not always, of course, but most of the time.
For example, if you open the EURUSD chart with an MN (monthly) time-frame, you will see that from April 1 to December 1, 2007, the price increased, and from April 1 to December 1, 2008, it declined. Then, from April 1 to December 1, 2009, it went up again. The movement was not clear in the following year and then, from April 1 to December 1, 2011, it declined some more. After that there was another period of uncertain movement, and you can assume that in the period from April 1 to December 1, 2013, the chart will go up.
Of course, any analysis, one way or another, is pretty subjective. After all, even after looking at the same data and following the same indicators, analysts are almost diametrically opposed. It is therefore important to not just look at the chart, but also be familiar with what is going on in the world. All quotes are affected by economic and political changes, and even the psychological mood of traders. That’s why you shouldn’t take technical analysis as the Holy Grail of successful trading. That simply isn’t true, however, it can be very useful in figuring out and understanding much about the behavior of prices.
What is technical analysis based on?
We’ve already talked about one aspect of technical analysis – the various types of charts. In the Terminal, charts are displayed using "Japanese Candlesticks" which is the analysis of where the price went (where it began and ended) during a specific period. Another type of chart we mentioned is the bar chart, which looks like this:
Just like Japanese Candlesticks, they show the opening price (the little line on the left), the closing price (sideway lines to the right), the maximum price (upper line) and the minimum price (the lowest point) during the specified time period. There is also a line graph (picture). This line is created automatically for each quote after the completion of each time period. Of course, you don’t always need to look at this detailed timetable. Just hover your cursor over a bar or candlestick and a little window will pop up that gives you all the important information: the time of opening, the maximum value (high), minimum value (low), the closing price and the number of ticks (volume), i.e., how many times the price changed during the specified time period.
Another aspect of technical analysis, in addition to the types of charts, is the direction of prices, i.e., the trend, and it’s channel.
What is a channel?
Every trend has a beginning, an end, and a range, within which the price fluctuates, not going outside the trend. Some traders argue that the emergence of each trend can be seen by the naked eye and they do not need any additional tools. This may be true, but this approach is only indirectly related to technical analysis. So if you discover a trend that is forming or has already formed, or have a clear indication of the direction of prices, you should outline it with two straight lines in order to identify the boundaries of the channel in which this trend will vary.
What types of trends are there?
If the price on the chart is moving upwards, then it’s a “Bullish” trend.
To determine it you need to, remember: the amplitude of the movement upwards must be greater than the amplitude of the downward movement in price.
Another type of trend is the downward one, or “Bearish.”
Here the opposite is true: the amplitude of downward movement in price should be greater than the amplitude of the upwards movement.
There is also one other direction – flat, which is horizontal or nearly horizontal price movement.
Most methods of technical analysis are geared towards trend trading. Traders even have a saying: "The Trend is your friend." This means that once you have determined the direction the price is currently moving, you should open your transaction in this direction, i.e., according to the current trend.
How long can trend last?
According to philosophically-minded traders, each trend experiences a beginning, a period of maturity, old age and finally, death. Based on the duration of its "life" each one can be identified as a short, medium or long-term trend. When you open the chart of any instrument in the M5 or M15 time-frame, you will be able to see and identify short-term trends. When you look at the H1 or H4 time-frames, you can look for medium-term trends, or day trends, and with the D1 and W1 views you can get an idea of the general tendencies of the price movement. There is also such thing as a global trend, or long-term trend, which may last a year or more. In order to view it, you need the monthly time-frame, MN. Many professional traders believe that by this principle you can only determine the movement of prices in a particular direction if the trend lasts for the entire trading session (around nine hours). That's when they are confirmed and can say “Yes, the trend is upward (or downward).” Perhaps this is a good rule to follow in most cases, but there are also situations where its beneficial to recognize in advance that a strong trend is about to begin. However, nobody can predict these trends with 100% certainty.
How does a trend form? Like everything in this world, every trend has a beginning, and the impetus for its creation could be a political or economic event, because the price doesn’t start changing on its own. There is always a reason and the most obvious catalyst is the news. A new quarterly report, the inflation rate, the results of elections, unemployment and jobs numbers, a change in the GDP, a flood, a terrorist attack or military strike - all this and much more can easily cause prices to change direction. So, technical analysis alone is not enough in order to really understand what’s happening on a chart and why. This is where fundamental analysis, which includes everything we listed above, becomes helpful. It helps to understand how the news affects the behavior of prices. We’ll discuss it in some more details in the next section.
In addition to the news, an upwards or downwards trend can also begin at the end of a flat trend. This is called consolidation. This is when the price seemingly accumulates (is consolidated) at the same level. Thus if you see that for, let’s say, half a day or even a whole day, the price hasn’t changed much and its movement has been frozen in one spot, we will soon have a pronounced trend. Typically, this consolidation of prices comes ahead of critical data (news). The market tends to freeze in anticipation, not knowing which direction is better to open transactions. This type of flat trend is quite often seen during lunch hours (in GMT), at the end of the year and before major holidays, when few participants are left in the market and their volume is simply not great enough to substantially affect the price.
What is the level of support and resistance?
You can see a much clearer trend in the H4 chart. Try to look more globally by capturing information about several days at a time. For example, although the chart for EURUSD from January 11th to January 25, 2013 shows the price was moving up and down, in general, the movement was in a single channel.
Let's build this channel. On the top panel above the chart window you will see a button with a horizontal line. Click it and then position it on your chart. You should place it at 1.3264. That positions it at the bottom of the "shadow" of our candlestick – you only need one to mark the lowest point on your chart.
This is the supporting level. We are talking about level precisely - we’ll explain lines later. This level is designated using a horizontal line. It acts as a “support” for our trend and “prevents” it from dropping lower. This border is actually psychological. You aren’t the only one that placed it there. So did thousands of other traders around the world and they (i.e. the "bulls") will not allow the price to drop below this mark. Now we need an upper bound for our trend. We will also use the horizontal line tool to place our upper bound on highest point of the highest candlestick, which would be at 1.33980. This level is called the resistance level.
The price will reach this level and then go down again due to the fact that the "bears,” focused on selling, will not allow it to go any higher. Notice how the candle initially rose up to the "resistance" level and then completely stopped, as if concentrating on the middle of the channel. This is a sign that a big change in movement is coming. As soon as the chart crosses either the support or resistance level, it figuratively breaks this level. This is called a pass. For example, when the price passes the resistance level, it means that there are more traders in the market willing to buy this instrument at a higher price. Conversely, when the chart passes through the support level, it means that the bears "won" and the number of people willing to sell has increased dramatically.
This “breakout” can be real, as in our case, when the price went through the resistance level and continued upwards, or fake, when the price breaks though the boundary and then returns to the channel.
What is the line of support and resistance?
First of all, levels and lines are completely different things.
We have outlined the levels, which again, are always horizontal. The support and resistance lines are placed at any angle using the trend line tool. You can find this button in the same place on the top panel. The resistance line now joins together the repeating highs at the tops of the candles (two or more), and the support line connects their lower shadows.
If you use the “Equidistant Channel" button, you can add two parallel lines to your chart. However, in order to make this you will have to do some practicing. After you place this channel on the chart, double-click on the line and you will see the "anchor" points, which you can use to drag the line in either direction.
What is the gap? A gap is a break in the quotation. If you take a look at, say, the five-minute chart of EURUSD from December 24-26, 2012 onwards, you will be able to see one.
You can also describe a gap as a sudden jump in prices. It happens, as in the example during the days after market closure (December 25th was Christmas and the market was closed). It turns out that the price at which the previous trading session closed is not the same as the quotation with which the new trading day began. Most often this happens when the head of the Central Bank or the Finance Minister gives a press conference or a meeting of OPEC countries or G8 Summit takes place - in general, a significant event occurs on a day when the market is closed, and it leads to sharp price changes
However, a gap can be seen within a trading day after, for example, the publication of some important market-related data (GDP numbers, inflation statistics, a change in interest rates), which dramatically increases the number of traders who want to buy a specific instrument (the gap is upwards), or those who want to sell it (the gap is downwards).
How do you trade on gaps?
Many traders will open a new transaction on a Friday night, expecting a possible gap on the following Monday. After all, this is a great chance to earn several dozen of points! But be prepared: a gap can happen both in the direction you expect, and in the opposite direction. Then, instead of your profit jumping, you may "jump" into a sizeable minus. But remember, a gap may not happen at all because it is the exception, rather than the rule. For deals that traders open one hour before the close of trading on Friday to catch the “gap" our company sets a margin of 1:33, so be careful.
A less risky way to earn is based on the assertion that the market is always trying to "work off" any gaps.
For example, if an upwards gap occurs, within the next few hours the price will work its way back down to close the “hole” that has formed in the price. If the market fails to close the gap that means that the new trend is too strong. In these cases, the upper bound of the gap can become a powerful level of support and the price will continue to rise.
And the reverse situation: if the gap occurs in downward movement and does not recover, the lower bound will become the level of resistance and the price will continue to move lower and lower.
What are the indicators?
We explained earlier that in the “Navigator” window there are many different indicators that can help you trade. Drag and drop a few into your chart to see what they look like, if you have not done so already. You should also understand that these indicators will help you analyze past price movement, but there is no indicator that will predict future movement on your chart. They are only programmed with the mathematical formulas for past prices. You can see that there are lines that are located either on the main chart, or underneath it.
You can use though all the indicators together, but, nevertheless, if you open a transaction in the wrong direction you will start to lose money. This can happen if the trader does not understand this main principle: price controls indicators, not the other way around Indicators just help you graphically depict what has already happened, but they don’t predict future movement.
What are the types of indicators?
In the list of indicators in the Terminal you will find, for example, the Moving Average and the Bollinger Bands indicators. See how they look and remember that they are trend indicators.
They clearly show upwards and downwards trends which are actually the easiest to detect.
The second type of indicators is called oscillators, which depict the "oscillation of parameters.” These indicators are displayed in a separate window and are usually depicted in the form of bar charts.
In the “Navigator” window you'll see the word Oscillator next to the names of some indicators. However, there are also other oscillators that are unmarked – e.g., MACD, which stands for the Moving Average Convergence/Divergence. This indicator works well when the market is flat, and helps determine when the price is going to change direction and go either up or down.
Other indicators may show very different things. For example, the Zig Zag indicator, which you can find in the list of customs indicators, weeds out any minor price fluctuations and shows only the clear direction of the trend. The Volume Level indicator can confirm whether a pass you noticed is a real or fake one. If the volume is increasing (the right column is taller than the left) then the pass is real and the price is likely to continue to go in that direction. There are lots of indicators, among which, for example, the Fractals indicator, which helps to detect the bottom or the top of a channel in which the price is moving. Thanks to this indicator we come to another important aspect: fractals.
What is a fractal?
This term was invented by Bill Williams, the founder of a trade group called Profirunity. A fractal is a specific combination of candlesticks or bars. There is a buy fractal, which consists of five consecutive candlesticks. In this type of fractal the center candlestick should contain the highest top (it is called the fractal point) and the two following candlesticks, lower tops.
Fractals are shaped like "arrowheads." The arrowhead indicates the direction the market will go. There are also selling fractals (downwards arrows) where the Central of five candlesticks contains the lowest minimum and is followed by two lower ones where the bottoms of the shadows are higher. It is important to remember that the lows on candlesticks or bars do not have any effect on buying fractals and, conversely the highs mean nothing for selling fractals.
How do you trade on Fractals?
Basic principle is that if the price exceeds the upper maximum of a buying fractal, then you should buy, and if the price is lower than the minimum of a selling fractal, then you should sell.
To make it easier to identify these fractals, you can use the fractals indicator, which you will find in the Terminal in the “Navigator” window. Drag it to your chart, pick a color, and you'll see a lot of fractals appear on the chart and each of them is represented by an up or down arrowhead.
What are Fibonacci lines?
They are also called grids and you can find the button to activate this interesting indicator on the upper panel of the Terminal. Surely you've heard of the scientist Leonardo Fibonacci, who was born during the late middle-ages in Pisa. By studying nature, talking with mathematicians and even watching two rabbits breed, he came to the conclusion that everything in our world is built on a system of numbers. The Galaxy, the human body, nature, mathematics – all are subject to a numerical sequence where each consecutive number is the sum of the previous two: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. In addition, these numbers are linked to each other by a very curious correlation. For example, each number is approximately 1.618 times more than the previous one, and each previous number constitutes approximately 0.618 of the next.
Taking this information into consideration, American financier Ralph Nelson Elliott speculated that psychology, mathematics and finance (the major "whales" of the market), in one way or another, are subject to the laws of those numbers. So, why not use them to predict the behavior of prices? As a result, several indicators were developed, one of which you have in your Terminal and it is called the Fibonacci Lines indicator. The principle of this indicator is that when the price nears one of these lines, the trend either changes or is confirmed. Quite often these lines end up becoming strong and precise support and resistance levels.
How do you set a Fibonacci line?
To begin we will choose the hourly time-frame (H1). This is the best one for viewing the entire trading day. Look at the chart and try to determine a point of strong impulse (i.e., a moment when the price receives a powerful impetus for movement up or down). The Zip Zag indicator can help you do that. So, let's find the two most outstanding points: the maximum and minimum, and then set the Fibonacci grid from the lower to the upper one, or from 100 to 0.
Note that we have now placed this indicator taking into consideration the entire shadow of the Japanese candlesticks because they reflect the real range of the price movement. Another point: if you can notice that the market goes up, then you should adjust your levels (minimum rate). To do this, click on it and drag the grid slightly to the right and up. That way, 100 will mark the lowest point and the highest point will be 0. The more you drag your mouse to the right, the less the distance will be between the lines.
If you see that the chart is going down and the grid needs to be "flipped" then identify the highest point, which we will mark at 100. Pull the grid slightly to the right and down, then 0 will coincide with the minimum price.
After you have set the grid, right-click on the chart and select the “Objects List.” There you will find Fibo. Click on "Properties" which are located on the right side and change the following setting in the General tab. Then, in the Levels tab, select a color for the lines and it is better to make them thicker for easier distinguishing on the chart. In the Options tab, check the box for "ray." Then the levels will appear like rays, from the starting point to infinity. In the View tab, you can either check the bos next to "Show in all time-frames,” or select a single time period and place a second, more global or more local grid.
That’s it! Now click "OK." To learn more about Fibonacci lines, see the very interesting book by Robert Fisher entitled "Fibonacci Applications and Strategies for Traders."
How do you trade using Fibonacci levels?
Generally, the principle for upwards or downwards movement is identical - the same levels are used
. In our case we will analyze the upward movement of prices. For your convenience, we will use a line graph instead of candlesticks or bars.
Now watch our low point - 100. Another strong level of resistance through which the price will very likely pass, although with difficulty, is 50. A level of 38.2 is a little less, but the price almost always holds steady. But, the price will always pass 23.6 without stopping – this is important to keep in mind. The upper level 0 is a powerful level of resistance, similar to a concrete wall. Thus, if you properly set the Fibonacci grid for upward motion, then you should buy between 100 and 61.8, and take profit between 61.8 and 50. You can also buy a little higher than the 38.2 and take profit before hitting 0. From 0, the price will go down, And at 0, you can place a pending order to sell (sell limit) with the take profit just above 38.2. The price will go down further from 0 and if it reaches 100, then you can place an order to sell just below this level with a take profit slightly higher than 161.8. Incidentally, at this point you can place a pending order to buy with a take profit of 10-15 points (from this point a roll-back or even a reversal is possible). You can also place this type of order at 261.8, but you don’t often see it on a chart.
You may ask why we choose such a small take-profit. The thing is that the price will not necessarily jump back from this level. It could simply slow down and then continue further. Do you remember the saying "the trend is your friend?" It turns out that you are opening a trade up against the trend, so be sure to place the stop loss almost immediately after the 161.8 or 261.8 (if it is visible) lines. By the way, instead of using a small take profit for such deals, it’s more convenient to set a trailing stop.
What is a trailing stop?
This function transfers your Stop Loss at break-even. You’ll understand what that means in a moment. Open any transaction, such as an order to buy. Then, in the "Terminal" window, right-click on it and select "trailing stop." In the drop-down menu, you can set the number of points. Let’s pick 15.
After placing a trailing stop, the following occurs. As soon as your transaction begins to make a profit, your stop loss will automatically be set for 15 points from the current price. As it continues to improve, your stop loss moves the same distance to stay at the 15 points setting If the price begins to drop, the stop loss doesn’t move, so even if the market flips and the price will not increase more, your transaction will be closed by the stop loss and you'll get the profit! Some traders use the trailing stop instead of the standard stop loss and take profit settings. Basically, the trailing stop is an insurance policy in case the price reverses and starts working against you.
What is the Elliott wave?
We have already told you about Ralf Nelson Elliot, the financier and founder of this curious and confusing wave theory. The essence of it is that people are trading on the market, so their decisions are, of course, based on psychology, which is also subject to the market. For many, the idea that market prices behave like waves (they rise and fall) seems obvious. This is the basic essence of Elliott waves, which can be seen on the chart with the naked eye. Elliott also said that the market is always in either a bearish or bullish phase. He divided waves into two types: impulse waves, which create trends (bullish or bearish) and lead the market into motion, and corrective waves, which traders also call kickbacks, because they move against the trend for a while.
It is curious also how Elliot uses the Fibonacci principle to explain his wave theory mathematically: the number of waves involved in forming a trend coincides numerically with the next! A global bearish wave consists of one large wave, three medium waves and 13 smaller ones. Additionally, in the same global wave are 55 very small waves, and so forth. Another example of the use of Fibonacci numbers is in the interim periods. For example, a movement that has lasted for more than 3 days should not change its direction before the 5th day. If it lasts more than 5 days, it shouldn’t end before the 8th day. Nine-day trends will not end before 13 days, and so on. By the way, this also applies to trends lasting hours, days, weeks, and even months! This is, of course, an idealistic model that is not often reflected with any degree of accuracy in real life. Even Elliott himself admitted that deviations can occur both in time and scope.
You can take a more in-depth look into trading with wave theory by reading Tom Joseph’s book called "Practical Applications of a Mechanical Trading System (using simplified Elliot Wave Analysis).”
What is the “hour of silence” and the “hour of power?”
The Forex market, on which you already know how to trade currency pairs, is open 24 hours a day, Monday through Friday, with a daily trading session (we mentioned that earlier). We also mentioned that the greatest trading activity happens during the Asian, European and American sessions. So, you need to remember that, when two of these sessions meet (they overlap in time), you can see very strong movement on the market - the “hour of power.” This makes sense because during this period there are more traders in the market, making more trades, and creating bigger volume. At the same time, before each session and immediately after it, the market is calm, flat, or in other words - the “hour of silence.” It’s as if the market is waiting to see what will change when new players join the trading. Of course, the term “hour of silence” is more of an expression than an actual rule as these periods of calm usually last not one, but two to three hours.
How do you use the hour of power and the hour of silence to your favor in trading?
This can be a useful time to conduct analytical activities. During an hour of silence, you can determine the levels of support and resistance, so that when new session begins, you can watch to see the direction of the breakout. Typically, the price will continue to move in this direction. For the Asian session, its best to set these levels from 02:00 to 08:00 in Terminal time (+2 GMT) and the best time-frames to use are M15 and M30. The most telling period before the American trading session will be from 14:00 to 16:00 hours.
How do you prepare a trading schedule?
Most likely, you have not yet decided which indicators are the best to use in your chart in order to maximize profit and most accurately analyze the market situation. Of course, there is no correct answer to this question, but it’s best to start with the most obvious indicators so that you don't get stuck. And it also helps to pick different colors and thicknesses for them. For example, try combining the Zig Zag, Fractals and Stochastic indicators. We didn't have time to tell you about the stochastic one yet. This indicator opens in a separate window, it’s very interesting and definitely worth taking a look at. You will see that it consists of two lines. One of them, by default is pale green and the other one is a dotted red line. To explain this indicator simply, when the green line crosses the red one and seemingly sits on top of it, then the price goes up.
If the green line dips down and then crosses back over the red one that indicates that the price is going to go down.
Let's summarize quickly. The Zig Zag indicator will show you a clear trend of prices without too much "noise." Based on the direction of the arrow in the Fractals grid, you will be able to decide whether to open a transaction to buy or sell; and the Stochastic indicator validates your intent. And don't forget about support and resistance levels, and it is best to start trading with the M15 time-frame.
In the next two sections we will give you a lot of useful information on how you can predict the behavior of prices and make a profit.
Before we start dealing with technical analysis, we want to tell you about one more important thing – order types. Actually when you analyze the market situation, you inevitably make predictions where the price will be in the near future. After you make your prediction, you'll probably want to open a deal right away and then, a little later, when the price will reach its top and start to move the other direction, it will be the ideal time to close your open positio! But, you don’t have to sit at your Terminal and wait for the price to reach your pre-decided level to open a transaction like this. You can simply program a “pending order” for that price level, i.e. an order to your broker to open a transaction, which is deferred in time. Here are a few examples.
Let's say you have analyzed the market situation and are predicting that the price will still fall a bit more, down to a level of 1.3145, then turn around and start going up.
So, it makes sense for you to wait to open your transaction until the price is lowest. To do this, open a "new order" and then in the "Type" field select "pending order." Because you want to buy at a price that is below the current one, this type of order is called a Buy Limit (or limit-order to buy). Next, choose at which price you want your transaction to open (i.e., when the order should be fulfilled). In our case we should enter 1.3145. Next, choose the volume with which you want to enter the market and also be sure to set your stop loss and take profit levels. Additionally, you can set the expiration date of the order.
If the transaction does not open before that date then we, as your broker, will simply delete it.
Here’s another example: Let’s say the price is currently rising, but you have analyzed its movement and are confident that it will reach 1.4410 and then immediately turn downwards. That would be the perfect time to open a sell transaction!
In this case, your pending order is called a Sell Limit, i.e., your selling transaction will be opened at a price above the current one. You set up this type of order in the same way as you would a Buy Limit.
One last example: Let’s say it’s not clear in which direction the price will go from the current level of 1.3184 and no available indicators can offer any hints. Then you decide: If the price rises by 10 points and reaches 1.3195, that will mean that it will continue to grow and that would be a good time to open a buy transaction (Buy Stop - buy above the current price). Furthermore, if the price goes down by the same ten points, then it will likely continue to go down, and it’s a good time to open s sell transaction (Sell Stop - sell below the current price).
These orders are created the same way as the previous ones. And one more very important thing: any order to buy, even a pending order, will be opened at the Ask price and closed at the Bid price. Any order to sell is opened at the Bid price and closed at the Ask price.
Now since you understand the different types of orders, we can proceed directly to the subject of technical analysis.
What is technical analysis?
Technical analysis involves studying the historical movement of a price and predicting where it will go in the future. You do this on the basis of those charts that you see in the Terminal. Right now, if you look at the chart for the EURUSD currency pair, you can say whether the price of this instrument is rising or falling. If you scroll back, you can see how the price behaved last month or even last year. You may be confused why you need to care what price was that long ago, but in practice, you will find that history repeats itself. Not always, of course, but most of the time.
For example, if you open the EURUSD chart with an MN (monthly) time-frame, you will see that from April 1 to December 1, 2007, the price increased, and from April 1 to December 1, 2008, it declined. Then, from April 1 to December 1, 2009, it went up again. The movement was not clear in the following year and then, from April 1 to December 1, 2011, it declined some more. After that there was another period of uncertain movement, and you can assume that in the period from April 1 to December 1, 2013, the chart will go up.
Of course, any analysis, one way or another, is pretty subjective. After all, even after looking at the same data and following the same indicators, analysts are almost diametrically opposed. It is therefore important to not just look at the chart, but also be familiar with what is going on in the world. All quotes are affected by economic and political changes, and even the psychological mood of traders. That’s why you shouldn’t take technical analysis as the Holy Grail of successful trading. That simply isn’t true, however, it can be very useful in figuring out and understanding much about the behavior of prices.
What is technical analysis based on?
We’ve already talked about one aspect of technical analysis – the various types of charts. In the Terminal, charts are displayed using "Japanese Candlesticks" which is the analysis of where the price went (where it began and ended) during a specific period. Another type of chart we mentioned is the bar chart, which looks like this:
Just like Japanese Candlesticks, they show the opening price (the little line on the left), the closing price (sideway lines to the right), the maximum price (upper line) and the minimum price (the lowest point) during the specified time period. There is also a line graph (picture). This line is created automatically for each quote after the completion of each time period. Of course, you don’t always need to look at this detailed timetable. Just hover your cursor over a bar or candlestick and a little window will pop up that gives you all the important information: the time of opening, the maximum value (high), minimum value (low), the closing price and the number of ticks (volume), i.e., how many times the price changed during the specified time period.
Another aspect of technical analysis, in addition to the types of charts, is the direction of prices, i.e., the trend, and it’s channel.
What is a channel?
Every trend has a beginning, an end, and a range, within which the price fluctuates, not going outside the trend. Some traders argue that the emergence of each trend can be seen by the naked eye and they do not need any additional tools. This may be true, but this approach is only indirectly related to technical analysis. So if you discover a trend that is forming or has already formed, or have a clear indication of the direction of prices, you should outline it with two straight lines in order to identify the boundaries of the channel in which this trend will vary.
What types of trends are there?
If the price on the chart is moving upwards, then it’s a “Bullish” trend.
To determine it you need to, remember: the amplitude of the movement upwards must be greater than the amplitude of the downward movement in price.
Another type of trend is the downward one, or “Bearish.”
Here the opposite is true: the amplitude of downward movement in price should be greater than the amplitude of the upwards movement.
There is also one other direction – flat, which is horizontal or nearly horizontal price movement.
Most methods of technical analysis are geared towards trend trading. Traders even have a saying: "The Trend is your friend." This means that once you have determined the direction the price is currently moving, you should open your transaction in this direction, i.e., according to the current trend.
How long can trend last?
According to philosophically-minded traders, each trend experiences a beginning, a period of maturity, old age and finally, death. Based on the duration of its "life" each one can be identified as a short, medium or long-term trend. When you open the chart of any instrument in the M5 or M15 time-frame, you will be able to see and identify short-term trends. When you look at the H1 or H4 time-frames, you can look for medium-term trends, or day trends, and with the D1 and W1 views you can get an idea of the general tendencies of the price movement. There is also such thing as a global trend, or long-term trend, which may last a year or more. In order to view it, you need the monthly time-frame, MN. Many professional traders believe that by this principle you can only determine the movement of prices in a particular direction if the trend lasts for the entire trading session (around nine hours). That's when they are confirmed and can say “Yes, the trend is upward (or downward).” Perhaps this is a good rule to follow in most cases, but there are also situations where its beneficial to recognize in advance that a strong trend is about to begin. However, nobody can predict these trends with 100% certainty.
How does a trend form? Like everything in this world, every trend has a beginning, and the impetus for its creation could be a political or economic event, because the price doesn’t start changing on its own. There is always a reason and the most obvious catalyst is the news. A new quarterly report, the inflation rate, the results of elections, unemployment and jobs numbers, a change in the GDP, a flood, a terrorist attack or military strike - all this and much more can easily cause prices to change direction. So, technical analysis alone is not enough in order to really understand what’s happening on a chart and why. This is where fundamental analysis, which includes everything we listed above, becomes helpful. It helps to understand how the news affects the behavior of prices. We’ll discuss it in some more details in the next section.
In addition to the news, an upwards or downwards trend can also begin at the end of a flat trend. This is called consolidation. This is when the price seemingly accumulates (is consolidated) at the same level. Thus if you see that for, let’s say, half a day or even a whole day, the price hasn’t changed much and its movement has been frozen in one spot, we will soon have a pronounced trend. Typically, this consolidation of prices comes ahead of critical data (news). The market tends to freeze in anticipation, not knowing which direction is better to open transactions. This type of flat trend is quite often seen during lunch hours (in GMT), at the end of the year and before major holidays, when few participants are left in the market and their volume is simply not great enough to substantially affect the price.
What is the level of support and resistance?
You can see a much clearer trend in the H4 chart. Try to look more globally by capturing information about several days at a time. For example, although the chart for EURUSD from January 11th to January 25, 2013 shows the price was moving up and down, in general, the movement was in a single channel.
Let's build this channel. On the top panel above the chart window you will see a button with a horizontal line. Click it and then position it on your chart. You should place it at 1.3264. That positions it at the bottom of the "shadow" of our candlestick – you only need one to mark the lowest point on your chart.
This is the supporting level. We are talking about level precisely - we’ll explain lines later. This level is designated using a horizontal line. It acts as a “support” for our trend and “prevents” it from dropping lower. This border is actually psychological. You aren’t the only one that placed it there. So did thousands of other traders around the world and they (i.e. the "bulls") will not allow the price to drop below this mark. Now we need an upper bound for our trend. We will also use the horizontal line tool to place our upper bound on highest point of the highest candlestick, which would be at 1.33980. This level is called the resistance level.
The price will reach this level and then go down again due to the fact that the "bears,” focused on selling, will not allow it to go any higher. Notice how the candle initially rose up to the "resistance" level and then completely stopped, as if concentrating on the middle of the channel. This is a sign that a big change in movement is coming. As soon as the chart crosses either the support or resistance level, it figuratively breaks this level. This is called a pass. For example, when the price passes the resistance level, it means that there are more traders in the market willing to buy this instrument at a higher price. Conversely, when the chart passes through the support level, it means that the bears "won" and the number of people willing to sell has increased dramatically.
This “breakout” can be real, as in our case, when the price went through the resistance level and continued upwards, or fake, when the price breaks though the boundary and then returns to the channel.
What is the line of support and resistance?
First of all, levels and lines are completely different things.
We have outlined the levels, which again, are always horizontal. The support and resistance lines are placed at any angle using the trend line tool. You can find this button in the same place on the top panel. The resistance line now joins together the repeating highs at the tops of the candles (two or more), and the support line connects their lower shadows.
If you use the “Equidistant Channel" button, you can add two parallel lines to your chart. However, in order to make this you will have to do some practicing. After you place this channel on the chart, double-click on the line and you will see the "anchor" points, which you can use to drag the line in either direction.
What is the gap? A gap is a break in the quotation. If you take a look at, say, the five-minute chart of EURUSD from December 24-26, 2012 onwards, you will be able to see one.
You can also describe a gap as a sudden jump in prices. It happens, as in the example during the days after market closure (December 25th was Christmas and the market was closed). It turns out that the price at which the previous trading session closed is not the same as the quotation with which the new trading day began. Most often this happens when the head of the Central Bank or the Finance Minister gives a press conference or a meeting of OPEC countries or G8 Summit takes place - in general, a significant event occurs on a day when the market is closed, and it leads to sharp price changes
However, a gap can be seen within a trading day after, for example, the publication of some important market-related data (GDP numbers, inflation statistics, a change in interest rates), which dramatically increases the number of traders who want to buy a specific instrument (the gap is upwards), or those who want to sell it (the gap is downwards).
How do you trade on gaps?
Many traders will open a new transaction on a Friday night, expecting a possible gap on the following Monday. After all, this is a great chance to earn several dozen of points! But be prepared: a gap can happen both in the direction you expect, and in the opposite direction. Then, instead of your profit jumping, you may "jump" into a sizeable minus. But remember, a gap may not happen at all because it is the exception, rather than the rule. For deals that traders open one hour before the close of trading on Friday to catch the “gap" our company sets a margin of 1:33, so be careful.
A less risky way to earn is based on the assertion that the market is always trying to "work off" any gaps.
For example, if an upwards gap occurs, within the next few hours the price will work its way back down to close the “hole” that has formed in the price. If the market fails to close the gap that means that the new trend is too strong. In these cases, the upper bound of the gap can become a powerful level of support and the price will continue to rise.
And the reverse situation: if the gap occurs in downward movement and does not recover, the lower bound will become the level of resistance and the price will continue to move lower and lower.
What are the indicators?
We explained earlier that in the “Navigator” window there are many different indicators that can help you trade. Drag and drop a few into your chart to see what they look like, if you have not done so already. You should also understand that these indicators will help you analyze past price movement, but there is no indicator that will predict future movement on your chart. They are only programmed with the mathematical formulas for past prices. You can see that there are lines that are located either on the main chart, or underneath it.
You can use though all the indicators together, but, nevertheless, if you open a transaction in the wrong direction you will start to lose money. This can happen if the trader does not understand this main principle: price controls indicators, not the other way around Indicators just help you graphically depict what has already happened, but they don’t predict future movement.
What are the types of indicators?
In the list of indicators in the Terminal you will find, for example, the Moving Average and the Bollinger Bands indicators. See how they look and remember that they are trend indicators.
They clearly show upwards and downwards trends which are actually the easiest to detect.
The second type of indicators is called oscillators, which depict the "oscillation of parameters.” These indicators are displayed in a separate window and are usually depicted in the form of bar charts.
In the “Navigator” window you'll see the word Oscillator next to the names of some indicators. However, there are also other oscillators that are unmarked – e.g., MACD, which stands for the Moving Average Convergence/Divergence. This indicator works well when the market is flat, and helps determine when the price is going to change direction and go either up or down.
Other indicators may show very different things. For example, the Zig Zag indicator, which you can find in the list of customs indicators, weeds out any minor price fluctuations and shows only the clear direction of the trend. The Volume Level indicator can confirm whether a pass you noticed is a real or fake one. If the volume is increasing (the right column is taller than the left) then the pass is real and the price is likely to continue to go in that direction. There are lots of indicators, among which, for example, the Fractals indicator, which helps to detect the bottom or the top of a channel in which the price is moving. Thanks to this indicator we come to another important aspect: fractals.
What is a fractal?
This term was invented by Bill Williams, the founder of a trade group called Profirunity. A fractal is a specific combination of candlesticks or bars. There is a buy fractal, which consists of five consecutive candlesticks. In this type of fractal the center candlestick should contain the highest top (it is called the fractal point) and the two following candlesticks, lower tops.
Fractals are shaped like "arrowheads." The arrowhead indicates the direction the market will go. There are also selling fractals (downwards arrows) where the Central of five candlesticks contains the lowest minimum and is followed by two lower ones where the bottoms of the shadows are higher. It is important to remember that the lows on candlesticks or bars do not have any effect on buying fractals and, conversely the highs mean nothing for selling fractals.
How do you trade on Fractals?
Basic principle is that if the price exceeds the upper maximum of a buying fractal, then you should buy, and if the price is lower than the minimum of a selling fractal, then you should sell.
To make it easier to identify these fractals, you can use the fractals indicator, which you will find in the Terminal in the “Navigator” window. Drag it to your chart, pick a color, and you'll see a lot of fractals appear on the chart and each of them is represented by an up or down arrowhead.
What are Fibonacci lines?
They are also called grids and you can find the button to activate this interesting indicator on the upper panel of the Terminal. Surely you've heard of the scientist Leonardo Fibonacci, who was born during the late middle-ages in Pisa. By studying nature, talking with mathematicians and even watching two rabbits breed, he came to the conclusion that everything in our world is built on a system of numbers. The Galaxy, the human body, nature, mathematics – all are subject to a numerical sequence where each consecutive number is the sum of the previous two: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. In addition, these numbers are linked to each other by a very curious correlation. For example, each number is approximately 1.618 times more than the previous one, and each previous number constitutes approximately 0.618 of the next.
Taking this information into consideration, American financier Ralph Nelson Elliott speculated that psychology, mathematics and finance (the major "whales" of the market), in one way or another, are subject to the laws of those numbers. So, why not use them to predict the behavior of prices? As a result, several indicators were developed, one of which you have in your Terminal and it is called the Fibonacci Lines indicator. The principle of this indicator is that when the price nears one of these lines, the trend either changes or is confirmed. Quite often these lines end up becoming strong and precise support and resistance levels.
How do you set a Fibonacci line?
To begin we will choose the hourly time-frame (H1). This is the best one for viewing the entire trading day. Look at the chart and try to determine a point of strong impulse (i.e., a moment when the price receives a powerful impetus for movement up or down). The Zip Zag indicator can help you do that. So, let's find the two most outstanding points: the maximum and minimum, and then set the Fibonacci grid from the lower to the upper one, or from 100 to 0.
Note that we have now placed this indicator taking into consideration the entire shadow of the Japanese candlesticks because they reflect the real range of the price movement. Another point: if you can notice that the market goes up, then you should adjust your levels (minimum rate). To do this, click on it and drag the grid slightly to the right and up. That way, 100 will mark the lowest point and the highest point will be 0. The more you drag your mouse to the right, the less the distance will be between the lines.
If you see that the chart is going down and the grid needs to be "flipped" then identify the highest point, which we will mark at 100. Pull the grid slightly to the right and down, then 0 will coincide with the minimum price.
After you have set the grid, right-click on the chart and select the “Objects List.” There you will find Fibo. Click on "Properties" which are located on the right side and change the following setting in the General tab. Then, in the Levels tab, select a color for the lines and it is better to make them thicker for easier distinguishing on the chart. In the Options tab, check the box for "ray." Then the levels will appear like rays, from the starting point to infinity. In the View tab, you can either check the bos next to "Show in all time-frames,” or select a single time period and place a second, more global or more local grid.
That’s it! Now click "OK." To learn more about Fibonacci lines, see the very interesting book by Robert Fisher entitled "Fibonacci Applications and Strategies for Traders."
How do you trade using Fibonacci levels?
Generally, the principle for upwards or downwards movement is identical - the same levels are used
. In our case we will analyze the upward movement of prices. For your convenience, we will use a line graph instead of candlesticks or bars.
Now watch our low point - 100. Another strong level of resistance through which the price will very likely pass, although with difficulty, is 50. A level of 38.2 is a little less, but the price almost always holds steady. But, the price will always pass 23.6 without stopping – this is important to keep in mind. The upper level 0 is a powerful level of resistance, similar to a concrete wall. Thus, if you properly set the Fibonacci grid for upward motion, then you should buy between 100 and 61.8, and take profit between 61.8 and 50. You can also buy a little higher than the 38.2 and take profit before hitting 0. From 0, the price will go down, And at 0, you can place a pending order to sell (sell limit) with the take profit just above 38.2. The price will go down further from 0 and if it reaches 100, then you can place an order to sell just below this level with a take profit slightly higher than 161.8. Incidentally, at this point you can place a pending order to buy with a take profit of 10-15 points (from this point a roll-back or even a reversal is possible). You can also place this type of order at 261.8, but you don’t often see it on a chart.
You may ask why we choose such a small take-profit. The thing is that the price will not necessarily jump back from this level. It could simply slow down and then continue further. Do you remember the saying "the trend is your friend?" It turns out that you are opening a trade up against the trend, so be sure to place the stop loss almost immediately after the 161.8 or 261.8 (if it is visible) lines. By the way, instead of using a small take profit for such deals, it’s more convenient to set a trailing stop.
What is a trailing stop?
This function transfers your Stop Loss at break-even. You’ll understand what that means in a moment. Open any transaction, such as an order to buy. Then, in the "Terminal" window, right-click on it and select "trailing stop." In the drop-down menu, you can set the number of points. Let’s pick 15.
After placing a trailing stop, the following occurs. As soon as your transaction begins to make a profit, your stop loss will automatically be set for 15 points from the current price. As it continues to improve, your stop loss moves the same distance to stay at the 15 points setting If the price begins to drop, the stop loss doesn’t move, so even if the market flips and the price will not increase more, your transaction will be closed by the stop loss and you'll get the profit! Some traders use the trailing stop instead of the standard stop loss and take profit settings. Basically, the trailing stop is an insurance policy in case the price reverses and starts working against you.
What is the Elliott wave?
We have already told you about Ralf Nelson Elliot, the financier and founder of this curious and confusing wave theory. The essence of it is that people are trading on the market, so their decisions are, of course, based on psychology, which is also subject to the market. For many, the idea that market prices behave like waves (they rise and fall) seems obvious. This is the basic essence of Elliott waves, which can be seen on the chart with the naked eye. Elliott also said that the market is always in either a bearish or bullish phase. He divided waves into two types: impulse waves, which create trends (bullish or bearish) and lead the market into motion, and corrective waves, which traders also call kickbacks, because they move against the trend for a while.
It is curious also how Elliot uses the Fibonacci principle to explain his wave theory mathematically: the number of waves involved in forming a trend coincides numerically with the next! A global bearish wave consists of one large wave, three medium waves and 13 smaller ones. Additionally, in the same global wave are 55 very small waves, and so forth. Another example of the use of Fibonacci numbers is in the interim periods. For example, a movement that has lasted for more than 3 days should not change its direction before the 5th day. If it lasts more than 5 days, it shouldn’t end before the 8th day. Nine-day trends will not end before 13 days, and so on. By the way, this also applies to trends lasting hours, days, weeks, and even months! This is, of course, an idealistic model that is not often reflected with any degree of accuracy in real life. Even Elliott himself admitted that deviations can occur both in time and scope.
You can take a more in-depth look into trading with wave theory by reading Tom Joseph’s book called "Practical Applications of a Mechanical Trading System (using simplified Elliot Wave Analysis).”
What is the “hour of silence” and the “hour of power?”
The Forex market, on which you already know how to trade currency pairs, is open 24 hours a day, Monday through Friday, with a daily trading session (we mentioned that earlier). We also mentioned that the greatest trading activity happens during the Asian, European and American sessions. So, you need to remember that, when two of these sessions meet (they overlap in time), you can see very strong movement on the market - the “hour of power.” This makes sense because during this period there are more traders in the market, making more trades, and creating bigger volume. At the same time, before each session and immediately after it, the market is calm, flat, or in other words - the “hour of silence.” It’s as if the market is waiting to see what will change when new players join the trading. Of course, the term “hour of silence” is more of an expression than an actual rule as these periods of calm usually last not one, but two to three hours.
How do you use the hour of power and the hour of silence to your favor in trading?
This can be a useful time to conduct analytical activities. During an hour of silence, you can determine the levels of support and resistance, so that when new session begins, you can watch to see the direction of the breakout. Typically, the price will continue to move in this direction. For the Asian session, its best to set these levels from 02:00 to 08:00 in Terminal time (+2 GMT) and the best time-frames to use are M15 and M30. The most telling period before the American trading session will be from 14:00 to 16:00 hours.
How do you prepare a trading schedule?
Most likely, you have not yet decided which indicators are the best to use in your chart in order to maximize profit and most accurately analyze the market situation. Of course, there is no correct answer to this question, but it’s best to start with the most obvious indicators so that you don't get stuck. And it also helps to pick different colors and thicknesses for them. For example, try combining the Zig Zag, Fractals and Stochastic indicators. We didn't have time to tell you about the stochastic one yet. This indicator opens in a separate window, it’s very interesting and definitely worth taking a look at. You will see that it consists of two lines. One of them, by default is pale green and the other one is a dotted red line. To explain this indicator simply, when the green line crosses the red one and seemingly sits on top of it, then the price goes up.
If the green line dips down and then crosses back over the red one that indicates that the price is going to go down.
Let's summarize quickly. The Zig Zag indicator will show you a clear trend of prices without too much "noise." Based on the direction of the arrow in the Fractals grid, you will be able to decide whether to open a transaction to buy or sell; and the Stochastic indicator validates your intent. And don't forget about support and resistance levels, and it is best to start trading with the M15 time-frame.
In the next two sections we will give you a lot of useful information on how you can predict the behavior of prices and make a profit.
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