| LEARN FOREX |
LEARN FOREX |
ENHANCE YOUR FX TRADING KNOWLEDGE
Buying and Selling (B/S) on the Forex Market
The Buying and Selling model is an easy process for any new forex trader. There is one simple principle for buying and selling – you buy one currency pair whilst selling another. For each currency pair, such as the commonly traded EUR/USD cross, there are two prices. There is the bid price (price at which the market buys) and the ask price (price at which the market sells). The difference between these is referred to as the spread.
When placing an order, you first need to choose an amount (how much you want to buy or sell). For example, if you make a decision to sell 100,000 EUR/USD. Then by clicking BUY/SELL you are actively opening a position in the fx market, and you will automatically receive a notification on your trading platform. You can also do the opposite of your initial operation by closing your position in the fx market (BUY/SELL 100,000 USD/EUR in this case). Read more about placing orders.
Another important aspect to consider is that the forex Buy and Sell rates are influenced by a variety of different factors. These may include currency rate differentials, global economic trends, political events, weather and even extreme situations such as war or terrorism. These are often referred to as fundamentals. Read more about fundamental factors that influence fx trading.
FOREX TRADING MARGINS
The margin is the amount of collateral required by fx traders to maintain their open positions on the forex market. Unlike stocks and commodities, there are no margin calls in forex. If an account falls below the required margin requirements, then all open positions are automatically closed. For example, if an fx trader buys one mini lot of the EUR/USD pair for 1.50 at 1:100 leverage, then they will need $150 of their account in margin to maintain that open position. Read more about leverage and margins.
FOREX CURRENCIES QUOTATION SYSTEM
In the forex market, currencies are quoted in pairs, for example, the GBP/USD or USD/JPY. The first currency in the pair is called the “base currency” and the second is called the “counter currency”. The basis for buying and selling is the “base currency”. For example, if a trader wants to buy EUR/USD, then he will buy Euros and sell Dollars. This means that he expects the Euro to gain against the Dollar. Every transaction on the fx market is double-sided, and performed with a buy/sell order.
FX ROLLOVER
If a trader holds an fx trade in the spot forex market overnight, this position is rolled over. In most cases, you are likely to either pay or receive a rollover fee. The rollover fee is determined by the differentiation between the interest rates which are priced into the 2 currencies that are being traded in the currency pair. The trade transaction is settled after 2 days. If positions are held overnight, then the forex broker closes forex trades at the conclusion of the trading day, (5 PM EST) and new trades are simultaneously opened.
For example, the USD/JPY pair is traded at 1.40, the JPY interest rate is 3.5% and the USD interest rate is 1.5%. The pip differentiation is 0.60 pips. As a result, if you were to be long on JPY and short on USD, your trade would be found at 0.60 pips higher than previously. The example was calculated out by completing the following calculation: (base currency interest ÷ counter currency interest) × (day/days) × (traded rate).
LEVERAGE ON THE FOREX MARKET
Leverage allows forex traders to control more currency in a trade than they have deposited in their trading account. This is where the real power of fx trading lies. Therefore, trading with the leverage system wisely can work in your favor, and bring you big profits.
With 1:100 leverage, an fx trader needs 1 unit of currency to control 100 units in the forex market. Thus, it would only take 100 units to control 1 mini lot (10K) in the fx market or 1000 units to control 1 standard lot (100K). Read more about leverage.
FOREX TRADING HOURS
The fx market is based on "spot transactions". The reason for this is that trading takes place 24 hours a day, 5 days a week. Trading never ceases in the forex market, apart for weekends and holidays. This includes Christmas and New Year’s Eve, when the fx market closes early.
HOW TO TRADE FOREX
In the dynamic world of fx trading, there is always something new to learn. Whether you are a beginner, intermediate or experienced fx trader – expanding your forex knowledge and keeping up to date with current global forex events is essential to successful trading. bforex understands the importance of enhancing your fx knowledge and offers you access to multiple tools. These consist of a number of diverse forex lessons that will give you the confidence you need to confidently trade in the fx market.
These valuable lessons are written and updated consistently by our experienced analysts. These lessons were created with every type of fx trader in mind. Therefore, our aim is to provide a valuable resource and enable you to gather additional tools for your forex trading experience. The lessons begin with an introduction to fundamentals, including an overview of fx concepts, such as supply and demand, currency pairs and interest rates. Also included are lessons on forex terminology, such as leverage, lots, margins and pips. More advanced lessons cover key aspects related to fundamental and technical Forex analyses.
bforex values all new customers, and we understand the importance of educating our traders to the highest level. The aim of bforex is to enable fx traders to confidently trade forex. We are confident that these lessons will enhance your forex knowledge and prove valuable and advantageous during your fx trading experience.
The following are our Forex lessons:
1. Fundamentals – Provides an outline of basic fx concepts, such as supply, demand, currency pairs and interest rates.
2. Pips, Lots, Leverage & Margins – Offers an explanation of common fx terms required for forex trading.
3. Placing Orders – Describes the variety of different forex orders and explains what various types of orders should be placed when trading on the fx market.
4. Technical Analysis: An Introduction to Chart Reading – Outlines the meaning of technical analysis, the art and science of reading a price chart, as well as the various types of charts that need to be analyzed for fx trading.
5. Support, Resistance, and Moving Averages – Offers an explanation of what causes support, resistance and moving averages.
6. Trends & Trendlines – Provides details on uptrends, downtrends and ranges, as well as an explanation on how to use trendlines for fx trading.
7. Indicators, part I: The Trend Followers – Offers an explanation of various types of trend-following indicators that are used to help analyze price movements in fx trading.
8. Indicators, part II: The Oscillators – Offers an explanation of various types of oscillating indicators that help in analyzing price movements during forex trading.
Forex traders often turn to a variety of economic data to determine where a particular country’s economy and currency may be headed next. This data may include the following: Gross Domestic Product (GDP), imports, exports, employment, unemployment, growth, debt and many other factors. Collectively, these are often referred to as the fundamentals. Therefore, fundamental analysis refers to the analysis of any data, as well as the actual price patterns of the currency itself. The price patterns frequently impact the value of the currency on the forex market.
Supply and Demand
Like any other market, the value of currencies respond to changes in supply and demand. For example, the value of the Dollar (USD) will rise when the demand for this currency rises. The Dollar will drop in value when too many Dollars are available on the market, or the demand for the USD declines.
Forex Currency Pairs
The world’s currencies trade in pairs - one currency’s value either rises or drops in comparison to another. In fx trading, each currency has a three-letter abbreviation, and the trailing currency of any pair is considered the base currency. The price at any given time tells you how much of the base currency is needed to equal exactly one unit of the leading currency.
For example, when the EUR/USD pair is priced at 1.5000, this means that it takes 1.5 US Dollars to exchange for 1 Euro. If the Euro rises in value, then the EUR/USD price will also rise as more US Dollars are needed to buy each Euro. Likewise, if the Euro drops in value, then the price of the EUR/USD pair will also drop as fewer US Dollars are now required to equal each Euro.
The value of the leading Forex currency is not the only factor in determining the value of a particular currency pair. Any change in the value of the base currency obviously also affects this relationship. So, in the same example, if the US Dollar now rises in value, then the EUR/USD pair would drop as fewer Dollars are now needed to buy each Euro. If the US Dollar drops in value, then the EUR/USD price would rise, as more US Dollars are now required to equal each Euro.
Interest Rates
Another key factor that influences the value of a given currency is the constantly changing interest rate determined by the central bank of a particular country.
For example, if the Federal Reserve (Fed) in the United States lowers its interest rate, then the value of the US Dollar usually drops, causing the EUR/USD pair to rise. If the Fed raises interest rates, then the US Dollar will typically go up as well, causing the EUR/USD to drop.
Central banks are always caught in a delicate balancing act. If a country’s currency gets too strong, its exports become too expensive and other countries may look elsewhere.
Higher interest rates also tend to attract more foreign investments, which is why the currency of that country frequently goes up with the interest rates. Meanwhile, cheaper interest rates tend to stimulate lending inside the country and therefore economic growth.
The world of forex is filled with unique concepts and terms. Here are some of the most common fx terms that you need to be familiar with whilst trading on the forex market:
Pips
Pip stands for percentage interest point and it is the smallest individual unit in forex trading. The pip is always the right-most digit of any fx price quote.
The exact value of an individual pip depends on the currency being traded. For example, the Euro is measured out to four decimal places, thus each pip equals 1/100th of a cent. The Yen, on the other hand, is measured out to two decimal places, thus one pip is one cent. That’s not to say that each pip is worth 1/100th of a cent in Profit – to calculate this, we need to introduce two other terms, lots and leverage.
Lots
Banks and other liquidity providers trade currency in lots. For example, if a standard lot is 100,000 (100K) units of the currency being traded, while a mini lot is 10,000 (10K) in the fx market, then these amounts would make trading prohibitive for the average trader. As a result, forex brokers introduced a concept called leverage.
Leverage
Leverage allows forex traders to control more currency in a trade than they have deposited in their trading account. This is where the real power of fx trading lies. Therefore, trading with the leverage system wisely can work in your favor, and bring you big profits.
With 1:100 leverage, an fx trader needs 1 unit of currency to control 100 units in the forex market. Thus, it would only take 100 units to control 1 mini lot (10K) in the fx market or 1000 units to control 1 standard lot (100K). Profit, therefore, is a factor of a forex trader's leverage X the amount and size of lots being traded X the amount of pip price moves in the fx trader's favor. Loss, likewise, is calculated in the same way when price moves against the fx trader.
For example, if a you buy 1 mini lot of the EUR/USD currency pair, then your account equity would increase or decrease by $1 for each pip of movement. If you buy 1 standard lot, then your account would increase or decrease $10 with each pip of price movement. Example 1, if the EUR/USD pair increases by 10 pips (10×$1) from 1.5000 to 1.5010 with mini lots, then this is a $10 increase. Example 2, if the EUR/USD pair increases by 10 pips (10×$10) from 1.5000 to 1.5010 with standard lots, then this is a $100 increase.
Trading on Margin
The margin is the amount of collateral required by fx traders to maintain their open positions on the forex market. Unlike stocks and commodities, there are no margin calls in forex. If an account falls below the required margin requirements, then all open positions are automatically closed. For example, if an fx trader buys one mini lot of the EUR/USD pair for 1.50 at 1:100 leverage, then they will need $150 of their account in margin to maintain that open position. If the price moves against the forex trader by one pip, then they will need $151 and if the price moves against the fx trader by 10 pips, then they will need $160.
If, on the other hand, a forex trader buys 1 standard lot of the EUR/USD pair for 1.50 at 1:100 leverage, then they will need $1500 of their account in margin to maintain that open position. If the price moves against the fx trader by one pip, then they will need $1510. Or if the price moves against them by 10 pips, then they will need $1600.
In forex trading, when you buy one currency, you need to sell another currency in exchange. If you anticipate that the price of the base currency is going to go up in comparison with the counter currency, then you can choose a buy position (go long). You can then close this position by selling when the higher price is reached. If instead, you think the price of the base currency will go down as compared to the counter currency, then you would sell and enter into a short position. The idea is to cover your position by buying back at a lower price.
Order Types
A market order is placed when an fx trader wants to enter into a position immediately, at the best available price at the time. One possible downside to a market order is if the markets are moving fast, your order might get filled at a different price from the one you wanted. The difference is called slippage.
Alternatively, if you are concerned about getting the right price, and are willing to wait and enter the market when those conditions are met, then you would place a pending order.
There are several different kinds of pending orders in forex trading:
• Buy Entry – This order is placed when a forex trader believes the price will begin to rise after first dropping to a certain level. It is executed when the asking price becomes equal to the pending order.
• Buy Stop – This order is placed when an fx trader believes the price will continue to rise after it breaks above a certain level. This type of pending order is also executed at the ask price.
• Sell Entry – This order is placed when an fx trader believes that the price will begin to fall after it reaches a certain level. It is executed when the bid price is equal to the pending order.
• Sell Stop – This order is placed when a forex trader believes that the price will continue to fall after it breaks below a certain level. This type of pending order is also executed at the bid price.
Stops
A stop loss (or a stop) is an additional type of pending order designed to stop your losses by automatically closing your position if the price moves in a direction different to what you expected.
If you are buying a long position, then you would set your stop somewhere beneath your entry to protect yourself from a sudden drop. If you are selling a short position, then your stop would be placed somewhere above it, just in case there is an unexpected rally. A stop can also follow the price once it moves in your favor, in which case it is known as a trailing stop.
A stop under a long position automatically closes if it is touched by the bid price and a stop placed over a short position is executed when it is touched by the ask price.
Take Profit
Another order which can close your position automatically is called a take profit order (TP). In the same way that a stop is intended to protect your position if something unexpected happens, a take Profit order ensures that your position is closed if your target price is reached when you are not available, or in a fast moving market where the price may touch the target too quickly to react. It is generally a good idea to have both a stop and a target when entering new positions.
A target is normally set above the current price if you are in a long position, and below the current price if you are in a short position. For long positions, the take profit order would be executed when the bid price becomes equal to the amount you set. For short positions, the ask price must equal the take profit amount.
The markets represent the struggle between two opposing force – the bulls, who want to push the price higher, and the bears, who wish to push it lower. As each side tries to overpower the other, they leave footprints behind. The advantage with technical analysis is that patterns often repeat themselves. Therefore, this can be very useful in predicting future price movements in the forex market.
Technical analysis is the art and science of reading a price chart to determine who is stronger, and who may win the struggle in the future.
Chart Types
There are three types of charts commonly used for the technical analysis of the forex market: (Inserted from website)
Line charts:
The line chart is the simplest form of charting. It displays the closing price for any given time period. However, it does not tell you very much about the opening price or price fluctuations during that period.
Bar charts:
In bar charts, the vertical bar displays the extremes. That is the highest and the lowest prices reached during a particular period. The short ticks on the sides of the bar chart depict where the period opened and closed. The bigger the bar, the wider the range of the struggle. The smaller the bar, the more agreement and consensus there was on the price. You can also see if the open and the close of the period occurred closer to the lowest price, the highest price, or somewhere in the middle.
Candlestick charts:
Candlestick charts were first used in Japan in the 12th century in an attempt to predict rice prices, and yielded remarkable accuracy. Like a bar chart, they display the open, close, high and low of any given period. Besides just answering the question “who is winning?”, they also indicate “who is stronger?” This is due to some easily recognizable characteristics such as the size of their bodies, the length of their wicks and their overall coloring.
Candlesticks on charts have wicks at both ends. The wick depicts the extremes, that is, the highest and lowest prices during that period. The candle body displays the opening and closing prices. Additionally, the color of the candle depicts who ultimately won. Green candles represent a higher close than open, while red candles represent a decline in the closing price from the open.
In the example on the right, you can see that the most recent candle opened at 1.4830, then dropped as low as 1.4820. It then went on to rise as high as 1.4860, and finally settled at the present closing price of 1.4850. This is 20 pips above where it started its journey.
In this manner, each candlestick tells us a complete story of what happened in the power struggle between bulls and bears during that particular period of time. Also, candlestick charts give us clues about who is growing stronger and who is weakening.
There is a special kind of candle called a “doji” – this is a candle where the open and closing price were the same, leaving the candle without a body at all. These candles look like a “+” and represent a moment of consensus – an agreement between buyers and sellers in the market, but also a moment of indecision as to the next direction.
In the chart to the left, you can see the bulls gradually losing strength as the rally comes to an end at the top, as evidenced by the shrinking candle body. Then a doji prints and we begin to see the bears slowly overpower the bulls as price begins to move back downward.
Timeframes
Each candle or bar on a chart represents a specific time period. This can be 1 minute, 5 minutes, 15 minutes, 30 minutes, an hour, 4 hours, a day, week, or an entire month. The timeframe refers to the amount of time it takes to print one candlestick on your chart.
Both of the charts on the right show the same time period, and the same price movement from 1.4710 up to 1.4840
The first chart is a longer timeframe, where each candle takes 1 hour to form. The second chart is a shorter timeframe, which shows the same move, but in 5-minute increments.
The timeframe you choose to use depends on the type of trade you want to execute. A long-term trend follower is likely to use a longer timeframe, a swing trader something in the middle, and a day trader or scalper more likely to choose one of the shorter timeframes.
Trading with Multiple Timeframes
One strategy for trading is to use multiple timeframes. In order to do this, you need to first identify the best chart to use for your particular style of trading. This will be your lower time frame. Then choose another chart for the higher one. The goal is to choose two charts that are far enough apart (a factor of 5 or as close to that as possible).
A long-term trader who uses a daily chart as the lower timeframe, for example, may occasionally glance up at a weekly chart as the higher one (since there are 5 days in 1 week). A day trader who uses a 5-minute chart as the lower timeframe would most likely use a 30-minute chart for the higher one (since a 15-minute chart is only a factor of 3, and may not provide a different enough perspective).
On the higher timeframe, you can decide if you wish to be a bull or a bear in regards to that particular currency pair (or you can also decide to stand aside and look for another pair if the market is sideways and showing no clear direction). Then you can switch to the lower timeframe and take entry signals as normal, but only in the direction you decided upon in the higher timeframe. A bull would be looking for long signals in order to buy, while disregarding any short signals. A bear would be looking to sell short and would disregard any long signals.
Trends do change direction eventually, but generally they tend to do so gradually. You can change your mind and choose a different direction, but only on the higher timeframe, not on the lower one. The idea behind multiple timeframe analysis is to reduce the number of false trades and to avoid the temptation to trade randomly in both directions at once.
As a price moves up and down on charts, it encounters “barriers” along the way. If a barrier acts like a floor and keeps the price from dropping any lower, then it is known in trading terminology as support. When it acts more as a ceiling and stands in the way of upward moves, it is called resistance.
What Causes Support & Resistance?
When a price is moving up, it means that more people are buying than selling. These bulls eventually need to take their profits. Likewise, bears that are waiting in the wings and looking for an opportunity to enter short, are more likely to do so the higher the price gets. When the amount of sellers eventually overpowers the buyers, a resistance level is formed (as shown in the illustration above when the price reached 1.4862).
Similarly, when a price is moving down, there are more sellers than buyers. The sellers will eventually need to cover their short positions and take profit. Likewise, if there are bulls waiting to buy, then the lower the price goes, the more tempting it becomes for them to enter into new long positions. Eventually, the number of buyers will overpower the sellers, creating a support level.
Since many traders use pending orders set at a specific level, the same level is likely to act as support or resistance multiple times until it finally breaks (as seen in the example above as we approach 1.4848 for the second time, now to test it as support).
There can be many different support and resistance levels at any given time, and the wise trader tries to be aware of as many of them as possible so as not to be caught by a surprise reversal. As the price approaches each of these levels, it will either break it and go on to the next, or it will bounce and reverse itself.
Moving Averages (MAs)
Additional levels of likely support and resistance can be identified by drawing moving averages. A moving average is simply a line chart that depicts the average value of a series of periods.
There are several different kinds of moving averages. Most are an average of the closing price, though they are sometimes also calculated on the high or the low of the periods being averaged.
When the value being plotted is a straight average with no modifications, we refer to it as a simple moving average. The blue line in the chart above represents a 21-period simple moving average (21 SMA). At any given time, its value reflects an average of the closing prices of the previous 21 candles.
Since the blue line is an average, it is by its very nature slow to respond to sudden movements in price. The red line in the chart above is an exponential moving average for the same 21 periods (21 EMA). Here, there is more value placed on the most recent candles. As you can see, it responds a bit faster to both the sudden drop in price, as well as the rally that follows. Both kinds can have advantages and disadvantages, depending on the situation.
As depicted in the above example, moving averages can act as both support and resistance when a price approaches them. But unlike regular support and resistance levels, they do not remain at one stationary level and can also move on your chart.
Common MA Strategies
People use moving averages in multiple ways. Traders will often check to see whether a price is trading above or below its moving average to decide if they are a bull or a bear (especially on a longer time frame).
As price gets closer to the moving average, traders look closely to see whether it will bounce back away from it or break that barrier, just as with any other support and resistance level. As the price moves further away from its moving average, the trade becomes ever more risky as price is thought to be out at an “extreme” (since the moving average is still an average, logic suggests that eventually it will meet again with the price at the same level).
Some people even use crosses of various different moving averages back and forth over one another to signal entries and exits.
Going Further
Advanced tools that can help us identify other likely support and resistance levels include pivot points and Fibonacci retracements and extensions. The common factor among all support and resistance levels is their likelihood to either break or bounce when the price reaches them, which is why it pays to be aware of them.
Avoiding False Breakouts: the Re-test
When the price breaks below a trendline that has been acting as support, it will typically come back up to test that same level again – but this time as resistance. The best short entries are not taken on the initial break, but rather on the second move downwards, following this “re-test” of the level in question.
A successful re-test is defined as a candle body closing outside that level. In the example below, we can see that price broke below the support, failed the first re-test as resistance, and then continued to successfully pass on the second attempt. This pattern is also known as a "good-bye kiss".
The same scenario can be reversed when the price breaks above a trendline that previously acted as resistance. In this case, we look for that same trendline to be re-tested as support prior to taking a long position.
The Trendline Break System
One of the simplest trading systems can be formed simply by using trendlines. In an uptrend, we connect the bottoms of the candle bodies. If we are long from before, we look to exit the trade as soon as the price breaks to the downside. If at the moment, we are absent from a trade, then we may think about taking a short position at this point.
Similarly, in a downtrend, we connect the tops of the candle bodies. If we are short from before, we look to exit our trade as soon as the price breaks to the upside. If we are not yet in a trade, we may consider taking a long position at this point.
There are three directions that trends can move in: up, down and sideways. An uptrend is defined as having higher highs and higher lows. Similarly, a downtrend is defined as having lower highs and lower lows. When a trend moves sideways, the price is said to be in a range.
Trendlines
Trendlines are created by drawing lines connecting the tops of support levels, as well as the lows or resistance levels. As shown in the Uptrend and Downtrend examples above, the highs and lows are used to mark support and resistance.
By connecting the prior tops and extending the line, traders can get an idea of where the resistance is likely to be in the future. Future support levels can be estimated by connecting the prior lows.
As long as price continues to obey these levels, we can continue to trade inside the range. This is under the condition that we remain aware of the other support and resistance levels that may be found inside of the range. The trendlines themselves become additional support and resistance levels.
When the price breaks past the support or resistance levels defined by a trendline, we look to make a trade in the same direction as the breakout. However, as 81% of all breakouts are usually false breakouts, there is a need for caution and an additional step is required to confirm them.
Avoiding False Breakouts: the Re-test
When the price breaks below a trendline that has been acting as support, it will typically come back up to test that same level again – but this time as resistance. The best short entries are not taken on the initial break, but rather on the second move downwards, following this “re-test” of the level in question.
A successful re-test is defined as a candle body closing outside that level. In the example below, we can see that price broke below the support, failed the first re-test as resistance, and then continued to successfully pass on the second attempt. This pattern is also known as a "good-bye kiss".
The same scenario can be reversed when the price breaks above a trendline that previously acted as resistance. In this case, we look for that same trendline to be re-tested as support prior to taking a long position.
The Trendline Break System
One of the simplest trading systems can be formed simply by using trendlines. In an uptrend, we connect the bottoms of the candle bodies. If we are long from before, we look to exit the trade as soon as the price breaks to the downside. If at the moment, we are absent from a trade, then we may think about taking a short position at this point.
Similarly, in a downtrend, we connect the tops of the candle bodies. If we are short from before, we look to exit our trade as soon as the price breaks to the upside. If we are not yet in a trade, we may consider taking a long position at this point.
An indicator, also called a study, is a tool that can be used to analyze price movements. Indicators usually fall into two main groups: trend-following and oscillating indicators. Trend-following indicators are the most useful when the price is trending in one direction or the other. Oscillating indicators are useful when a price is consolidating into a range. It is important to know which group the indicator you are using falls into, and to choose the correct indicator for every scenario.
Some common trend-following indicators include:
ADX
The Average Directional Index is a special type of trend-following indicator that can also help a forex trader decide whether a trend follower is, in fact, the best tool for the job at that particular moment. Trend-following indicators will function best when the ADX is over 30. When it is below 30, then an oscillating indicator may be a better choice.
When the ADX is rising, this indicates that the trend is gaining in strength. When it begins to decline, it is a sign that the trend is losing steam and a trading range may soon develop. Likewise, when ADX begins rising again it indicates that the price is breaking out of its range and a new trend may emerge. However, the ADX only indicates the strength of the trend and does not show the direction in which it is going (up or down).
In the example below, note how the ADX starts off low as the price is trading within a range near the left side of the chart. Then, as the price starts to drop, the ADX rises above 30 to indicate a trend in progress. The ADX also confirms that the trend is over by beginning to decline once again. Then when it finally drops below 30, we find ourselves trading once again in a tight range.
MACD
Moving Average Convergence Divergence measures the difference between a short-term and longer-term moving average. When the red line crosses above the blue line, it indicates an uptrend and when the red crosses below the blue line, it indicates a downtrend.
Additionally, the green bars (called the MACD histogram) give us an indication of the trend’s strength or weakness. Unlike the ADX, they also show us the overall direction of the trend. Longer bars indicate increasing strength and shorter bars indicate decreasing strength.
In the following example, we can see that the red MACD line falls below the blue one as the price begins its move downward. The green bars in the histogram are increasing in length as well, indicating that the down-trend is gaining momentum. When price reverses to move up, the histogram reflects a loss of downward strength. Downward strength resumes as the next long red candle posts on the chart. However, it is important to note that while the price made a lower low, the histogram did not make it quite as far down. This is known as a bullish divergence and indicates that the trend will soon end and be followed by a reversal.
Momentum
The momentum indicator measures the rate of change in closing prices and functions very similarly to the MACD histogram. It is often useful in identifying likely reversal points due to its ability to detect trend weakness.
In the example below, the momentum indicator perfectly identifies the point at which the downtrend ends and the new uptrend emerges. As we near the end of the downtrend, the momentum indicator begins tracing a bullish divergence. When momentum is below zero and turns sharply upwards following a bullish divergence, it can signal a long entry. Similarly, when it is above zero and turns sharply downwards following a bearish divergence, it can indicate a potential short entry. As we near the right edge of the chart, we see that momentum is indicating that the uptrend is nearing an end and a reversal may be imminent.
Linear Regression
Linear regression is a special kind of moving average that is more responsive to price changes and with less delay. When a price makes an extreme move away from its linear regression line (the red line in the chart below), a quick counter-trend trade can sometimes be taken as price snaps back to “normal” – with the same linear regression line also acting as the target for taking profits.
Oscillating indicators get their name due to their tendency to oscillate within a range of values. They can signal when a price is at extreme levels and due for a reversal.
Some common oscillating indicators include:
Stochastics
Stochastics consist of a fast line and a slow line, and oscillate between 0 and 100. Levels above 80 are said to be over-bought and levels below 20 are referred to as over-sold. When the red line crosses above the blue, we know that the bulls are overpowering the bears. On the other hand, when the red line crosses below the blue, we know that the bears are beginning to overpower the bulls.
It is best to enter long positions when stochastics first cross above 20, returning from over-sold conditions. This indicates the greatest amount of “room” left for an upward move. As stochastics near 80, we know that we are closer to the end of the move rather than the beginning of it, and may consider staying out of the trade (if not already in it). As the stochastics begin to turn and cross, we are given a signal to close any remaining long positions.
As they cross back below 80 and return from over-bought conditions, we may look to enter short. If the stochastics are closer to 20 than to 80, we may wish to think twice about entering into any new short positions. Once they cross, we would also look to close any short positions already open from before. Then, as the stochastics break above 20, the cycle repeats and we begin looking to enter long once again.
RSI
The Relative Strength Index is similar in its function to stochastics, except it uses 30 to indicate over-sold conditions and 70 to indicate over-bought.
RSI signals a potential long when it breaks above 30 and a potential short if it comes from above and breaks below 70. In addition, levels above 50 confirm an uptrend, while levels below 50 indicate a downtrend.
CCI
The Commodity Channel Index is another oscillator but unlike the others it has 0 in the middle and ranges from -300 to +300. Levels above +200 are thought to be over-bought, while levels below -200 are considered as over-sold.
An fx trader can consider entering long when the CCI hooks up from any level that is below -200, or going short when it hooks down from above +200. In addition, if the CCI drops towards 0 but bounces back up from it instead of crossing below, then look to enter long. Likewise, if the CCI is rising up towards 0 from underneath it and then bounces back down without crossing above, that usually signals a potential short. These are known as continuation patterns.
Fractals and the Alligator Indicator
Fractals are simple markers highlighting candles that are extremes; i.e. candles that make a new high but have lower ones on either side, or candles that make a new low but have higher candles surrounding them. Fractals indicate likely reversal points and are even more powerful when filtered with the alligator indicator.
The alligator is made up of three lines, forming its mouth and tongue. When the alligator opens its mouth, a new trend is emerging and we can continue to trade this trend until we see signs that the alligator’s jaw is about to snap shut. After the alligator eats, he sleeps, but the longer he sleeps the hungrier he gets again. It is because of this sleep and hunger cycle that the alligator indicator is sometimes considered part of the oscillator family.
Longs should be kept open if a fractal appears but is below the alligator’s tongue. Short positions can remain open if the fractal is higher than the alligator’s tongue.
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28-January-2011 |
11:56 AM |
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