“Support and resistance” is one of the most widely used concepts in forex trading. Strangely enough, everyone seems to have their own idea of how you should measure support and resistance. Let’s take a look at the basics first.
Trend lines are probably the most common form of technical analysis in forex trading. They are probably one of the most underutilized ones as well. If drawn correctly, they can be as accurate as any other method. Unfortunately, most forex traders don’t draw them correctly or try to make the line fit the market instead of the other way around.
If we take this trend line theory one step further and draw a parallel line at the same angle of the uptrend or downtrend, we will have created a channel. No, we’re not talking about ESPN, National Geographic Channel, or Cartoon Network. These channels aren’t television channels, they’re trend channels, sometimes also called price channels.
Now that you know the basics, it’s time to apply these basic but extremely useful technical tools in your trading. Because here at dnbcmarkets.com we want to make things easy to understand, we have divided how to trade support and resistance levels into two simple ideas: the Bounce and the Break.
In the previous lessons, you learned about trading support and resistance. Let’s review what you’ve learned. When the price moves up and then pulls back, the highest point reached before it pulls back is now resistance. As the price continues up again, the lowest point reached before it climbs back up is now support.
Just like humans, candlesticks have different body sizes. And when it comes to forex trading, there’s nothing naughtier than checking out the bodies of candlesticks! Long bodies indicate strong buying or selling. The longer the body is, the more intense the buying or selling pressure. This means that either buyers or sellers were stronger and took control.
What do spinning tops, marubozus, and dojis have in common? They’re all the basic types of Japanese candlesticks! Let’s take a look at each type of candlestick and what they mean in terms of price action.
Now that you’re familiar with basic candlestick patterns like spinning tops, marubozus, and dojis, let’s learn how to recognize single candlestick patterns. When these types of candlesticks appear on a chart, they can signal potential market reversals. Here are the four basic single Japanese candlestick patterns
What’s better than single candlestick patterns? DUAL candlestick patterns! To identify dual Japanese candlestick patterns, you need to look for specific formations that consist of TWO candlesticks in total.
To identify triple Japanese candlestick patterns, you need to look for specific formations that consist of three candlesticks in total. These candlestick formations help traders determine how the price is likely to behave next. Some three candlestick patterns are reversal patterns, which signal the end of the current trend and the start of a new trend in the opposite direction.
Did you click here first? If you did, stop reading right now and go through the entire Japanese Candlesticks Lesson first! If you’re REALLY done with those, here’s a quick one-page reference cheat sheet for single, dual, and triple Japanese candlestick formations. This cheat sheet will help you to easily identify what kind of candlestick pattern you are looking at whenever you are trading. Go ahead and bookmark this page… No need to be shy!
In this section, we will be looking at these basic candlestick patterns that we have learned in the previous sections to make sound trading decisions. Remember, candlesticks are useless on their own, and you must always consider market environment and what price is telling you. But before we begin, just a few words of caution… As with any technical indicator or tool, if candlesticks point to a reversal or continuation that does NOT mean it will happen.
A lot of the time, markets are “noisy.” Not every candlestick useful when thinking about future price movements. Instead of looking at every candlestick, focus on the ones where the price is currently trading near important support and resistance levels. So first identify where you think these levels are, and then start looking out for candlestick patterns.
We’ve covered a lot about Japanese candlesticks. Hopefully, you’re not at wick’s end but are actually now fired up about candlestick charts. Maybe we’ve even ignited a flame that becomes a lifelong passion for Japanese candlesticks.
We will be using Fibonacci ratios a lot in our trading so you better learn it and love it like your mother’s home cooking. Fibonacci is a huge subject and there are many different Fibonacci studies with weird-sounding names but we’re going to stick to two: retracement and extension. Let us first start by introducing you to the Fib man himself…Leonardo Fibonacci.
Let’s talk about Fibonacci retracement levels. Fibonacci retracement levels are horizontal lines that indicate the possible support and resistance levels where price could potentially reverse direction. The first thing you should know about the Fibonacci tool is that it works best when the market is trending. The idea is to go long (or buy) on a retracement at a Fibonacci support level when the market is trending UP.
Back in Grade 1, we said that support and resistance levels eventually break. Well, seeing as how Fibonacci levels are used to find support and resistance levels, this also applies to Fibonacci! Fibonacci retracements do NOT always work! They are not foolproof.
Like we said in the previous section, using Fibonacci levels can be very subjective. However, there are ways that you can help tilt the odds in your favor. While the Fibonacci retracement tool is extremely useful, it shouldn’t be used all by its lonesome self. It’s kinda like comparing it to NBA legend Kobe Bryant. Kobe was one of the greatest basketball players of all time, but even he couldn’t win those titles by himself. He needed some backup.
Another good tool to combine with the Fibonacci retracement tool is trend line analysis. After all, Fibonacci retracement levels work best when the market is trending, so this makes a lot of sense! Remember that whenever a pair is in a downtrend or uptrend, traders use Fibonacci retracement levels as a way to get in on the trend. So why not look for levels where Fib levels line up right smack with the trend?
If you’ve been paying attention in class, you’d know by now that you can combine the Fibonacci retracement tool with support and resistance levels and trend lines to create a simple but super awesome trading strategy. But we ain’t done yet! In this lesson, we’re going to teach you how to combine the Fibonacci retracement tool with your knowledge of Japanese candlestick patterns that you learned in Grade 2.
The next use of Fibonacci will be using them to find targets. Gotta always keep in mind “Zombieland Rules of Survival #22” – When in doubt, know your way out! Let’s start with an example in an uptrend. In an uptrend, the general idea is to take profits on a long trade at a Fibonacci Price Extension Level. You determine the Fibonacci extension levels by using three mouse clicks.
Probably just as important as knowing where to enter or take off profits is knowing where to place your stop loss. You can’t just enter a trade based on Fib levels without having a clue where to exit. Your account will just go up in flames and you will forever blame Fibonacci, cursing his name in Italian.
Let’s review what we’ve learned about trading Fibonacci. The key Fibonacci retracement levels to keep an eye on are: 23.6%, 38.2%, 50.0%, 61.8%, and 76.4%. The levels that seem to hold the most weight are the 38.2%, 50.0%, and 61.8% levels, which are normally set as the default settings of most forex charting software.
Moving averages are one most commonly used technical indicators. A moving average is simply a way to smooth out price fluctuations to help you distinguish between typical market “noise” and the actual trend direction. By “moving average”, we mean that you are taking the average closing price of a currency pair for the last ‘X’ number of periods.
A simple moving average (SMA) is the simplest type of moving average. Basically, a simple moving average is calculated by adding up the last “X” period’s closing prices and then dividing that number by X. Confused??? Don’t worry, we’ll make it crystal clear.
As we said in the previous lesson, simple moving averages can be distorted by spikes. We’ll start with an example. Let’s say we plot a 5-period SMA on the daily chart of EUR/USD. The closing prices for the last 5 days are as follows: Day 1: 1.3172 Day 2: 1.3231 Day 3: 1.3164
By now, you’re probably asking yourself, which is better? The simple or the exponential moving average? First, let’s start with the exponential moving average. When you want a moving average that will respond to the price action rather quickly, then a short period EMA is the best way to go. These can help you catch trends very early (more on this later), which will result in higher profit. In fact, the earlier you catch a trend, the longer you can ride it and rake in those profits (boo yeah!).
One sweet way to use moving averages is to help you determine the trend. The simplest way is to just plot a single moving average on the chart. When price action tends to stay above the moving average, it signals that price is in a general UPTREND. If price action tends to stay below the moving average, then it indicates that it is in a DOWNTREND.
By now, you know how to determine the trend by plotting on some moving averages on your charts. You should also know that moving averages can help you determine when a trend is about to end and reverse. As trend traders, you want to recognize and ride the trend for as long as possible. You have to know when to get in AND when to get out.
What are moving average envelopes? Let’s rewind and briefly talk about moving averages first. The goal of using moving averages is to identify trend changes. While moving averages are a useful tool to have in your technical analysis toolbox, they can be susceptible to providing false signals.
The Guppy Multiple Moving Average (GMMA) indicator provides an interesting approach using moving average ribbons. As a trend trader, it’s not enough to just identify the direction of a trend and catch the trend. Trend trading success depends not only properly identifying the trend direction and catching the trend after it has started, but also on getting out as soon as possible after the trend has reversed.
There are many types of moving averages. The two most common types are a simple moving average and an exponential moving average. Simple moving averages are the simplest form of moving averages, but they are susceptible to spikes. Exponential moving averages put more weight to recent price, which means they place more emphasis on what traders are doing now. It is much more important to know what traders are doing now than to see what they did last week or last month.
Congratulations on making it to the 5th grade! Each time you make it to the next grade you continue to add more and more tools to your trader’s technical analysis (TA) toolbox. “What’s a trader’s toolbox?” you ask. Simple!
What is MACD? MACD is an acronym for Moving Average Convergence Divergence. This technical indicator is a tool that’s used to identify moving averages that are indicating a new trend, whether it’s bullish or bearish. After all, a top priority in trading is being able to find a trend, because that is where the most money is made.
Keltner Channels is a volatility indicator introduced by a grain trader named Chester Keltner in his 1960 book, How To Make Money in Commodities. A revised version was later developed by Linda Raschke in the 1980s. Linda’s version of the Keltner Channel, which is more widely used, is quite similar to Bollinger Bands in that it also consists of three lines.
Up until now, we’ve looked at indicators that mainly focus on catching the beginning of new trends. Although it is important to be able to identify new trends, it is equally important to be able to identify where a trend ends. After all, what good is a well-timed entry without a well-timed exit?
The Stochastic oscillator uses a scale to measure the degree of change between prices from one closing period to predict the continuation of the current direction trend. The 2 lines are similar to the MACD lines in the sense that one line is faster than the other.
Relative Strength Index, or RSI, is a popular indicator developed by a technical analyst named J. Welles Wilder, that help traders evaluate the strength of the current market. RSI is similar to Stochastic in that it identifies overbought and oversold conditions in the market. It is also scaled from 0 to 100. Typically, readings of 30 or lower indicate oversold market conditions and an increase in the possibility of price strengthening (going up).
The Williams Percent Range, also called Williams %R, is a momentum indicator that shows you where the last closing price is relative to the highest and lowest prices of a given time period. As an oscillator, Williams %R tells you when a currency pair might be “overbought” or “oversold.” Think of it as a less popular and more sensitive version of Stochastic.
When trading, it can be helpful to gauge the strength of a trend, regardless of its direction. And when it comes to evaluating the strength of a trend, the Average Directional Index is a popular technical indicator for this purpose. The Average Directional Index, or ADX for short, is another example of an oscillator. ADX fluctuates from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend.
Ichimoku Kinko Hyo? Yes, you’re still in the right place. You’re still in the School of Pipsology and not in some Japanese pop or anime site. No, “Ichimoku Kinko Hyo” ain’t Japanese for “May the pips be with you.” but it can help you grab those pips nonetheless. Ichimoku Kinko Hyo (IKH) is an indicator that gauges future price momentum and determines future areas of support and resistance. Now that’s 3-in-1 for y’all! Also, know that this indicator is mainly used on JPY pairs.
Now that you know how some of the most common chart indicators work, you’re ready to get down and dirty with some examples. Better yet, let’s combine some of these indicators and see how their trade signals pan out. In a perfect world, we could take just one of these indicators and trade strictly by what that indicator told us.
Now on to the good stuff: Just how profitable is each technical indicator on its own? After all, forex traders don’t include these technical indicators just to make their charts look nicer. Traders are in the business of making money! If these indicators generate signals that don’t translate into a profitable bottom line over time, then they’re simply not the way to go for your needs!
Everything you learn about trading is like a tool that is being added to your forex trader’s toolbox. Your tools will give you a better chance of making good trading decisions when you use the right tool at the right time.