Studying the Forex Market

Successful Forex trading relies heavily on research and analysis. There are basically two forms of analysis that can be used in Forex trading – or any form of financial trading for that matter – and they are fundamental analysis and technical analysis. Fundamental analysis is the study of macroeconomic factors; those factors that can impact economies on a large scale. Those that use fundamental analysis will tend to study major market developments, basic economics and the world news to look for indications that will affect future prices.

By contrast, technical analysis is based on the concept that all external factors are already taken into account by the price, creating an efficient market. Traders that use technical analysis believe that past price action is an indicator of future price action. Technical analysis involves the studying of the Forex market by looking at charts and trying to identify patterns and trends that will help forecast how prices will perform moving forward. To successfully employ technical analysis, you need to have an understanding of how to study the Forex market and the various patterns it produces.

The Basics

The Forex market is actively traded on a huge scale with many large players – such as managers of big funds or major financial institutions - trading the market on a daily basis. Given the fact that technical analysts believe that all the factors that can affect a price are already factored into the price and that there is such significant money being traded on the Forex markets each day it is safe to assume that major price inconsistencies rarely exist. As such, reading trends and the flow of the market is of greater importance than trying to seek out rates that are mispriced.

Support and Resistance Levels

Studying the Forex MarketLines of support and resistance are a simple aspect of technical analysis. To add support and resistance lines to a price line chart, you would simply mark points where the price stops rising and starts to fall (resistance levels) and points where the price stops falling and starts to rise (support levels). Basically, where the resistance levels are where the sellers enter the market and previous buyers start to sell. The support levels are where the buyers enter the market and previous short sellers start to cover their trades.

Support and resistance levels can be very useful in highlighting patterns within charts. However, they should be regarded as areas on a chart rather than exact points as it is not an exact science. A currency pair may rise above the resistance line before falling again and it may fall below the support line before rising again.

Trend Lines

In the Forex market, trends are regularly apparent in currency pairs, and can be either a positive trend, where the price is moving in an upward direction, or a downward trend, where the price is moving in a downward direction. It should be noted that a trend is formed when the price is generally moving in one direction, but there will still be fluctuations in the price during that trend. Forex traders that use technical analysis try to determine whether any given currency pair will trend in a particular direction or whether it will remain within the confines of a certain range.

By drawing a trend line on a price chart - one that connects either the support lines or the resistance lines - it is possible to see whether a trend is forming. If the line is heading in an upward diagonal direction then an upward trend is forming while if it is heading in a downward diagonal direction then a downward trend is forming. If the line is relatively horizontal, then the currency pair is not trending – or moving sideways.

Generally speaking, the steeper the trend line, the less accurate it is likely to be and the greater the possibility that it will break. Currency pairs rarely move quickly, in either direction, for particularly long periods and steep trend lines tend to be broken by the market.

Channels and Ranges

Channels on price charts are created where two trend lines are parallel to each other and the price of the currency pair is bouncing between the two lines to create a range. Channels can be uptrends, they can be downtrends or they can be sideways. A channel can be interpreted as a trading zone and if you can identify a channel where the price is consistently moving fairly precisely between the two lines then you can make trades accordingly. For example, you can enter a long position when the price hits the bottom of the channel and exit that position when the price hits the top of the channel. Alternatively, you can enter a short position when the price hits the top of the channel and exit that position when the price hits the bottom of the channel.

This is often referred to as “playing the bounce”. Having identified the relevant lines, you should be waiting for the price to touch one of those lines you should wait for confirmation of either the support or resistance level when the price “bounces” off the trend line. Playing the bounce is a relatively safe way to trade, providing the channel is well established. However, there is never a guarantee that a pattern will continue and a price could break out of the channel (ie. move above the resistance level or below the support level) at any time.

Some traders prefer to “play the break”. This is forex trading on the basis that a trend line will break at some point as either the support or resistance lines that are established fail to hold. Trends can continue for substantial periods of time, but the market dictates that they must all break eventually. A trader playing the break will wait for a price movement that goes through the support or resistance line by an abnormal amount and then place an order accordingly.

If the price has gone through the support line then a short position will be entered, whereas a long position will be entered if the price has gone through the resistance line. Playing the break is considered a more risky trade as it is less likely to be successful than playing the bounce. You may well experience a number of losing trades using this particular strategy; however one winning trade could still mean you are profitable overall.