Using technical analysis can be as easy or difficult as you choose it to be. Far too many traders have found trading to be a very difficult endeavor when it really doesn’t have to be. It really comes down to figuring out two important things: What direction the market is moving in overall, and where buyers and sellers are. It really is that simple, but people tend to get confused by the various timeframes, salespeople out there willing to sell information, and general market noise. The beauty of the currency markets is that you can make them as simple or difficult as you want them to be. The choice really is up to you.
Looking at the first important piece of information, we need to understand the overall direction of the marketplace. There are plenty of people that will say things like “The daily chart in is an uptrend, the 4 hour chart is flat, but the 15 minute chart is in a downtrend.” This leads to confusion, and quite frankly, does no good for the trader unless the idea is to drain the account of funds. The truth is that you can make this fairly easy, and know that you are with the overall trend in a simple manner: looking at the weekly chart, notice if the price is going from the lower left to the upper right. If it is, you are in an uptrend, no matter what price is doing over the last several hours. Many traders will get sucked into shorting this market because of what is essentially a minor pullback, a blip on the screen in a long sea of green candles. Of course, the opposite is true: buying in down trends can happen as a result of the bounce or pullbacks you see from time to time.
When you look at the following chart, you can see that for a majority of the time from 2002, the USD/JPY has been falling. So in that scenario, you are going to have much more momentum and strength to the downside in this pair. Knowing this, you can simply your trading by looking for weakness in the pair.
While knowing the trend is important, you also need to know where price is most likely going to move in that direction. This is where the concepts of support and resistance come into play. The main reason we are marrying the two concepts is that you are following what the larger participants in the market are doing. Who would you rather follow in this arena: large banks and funds, or some guy down the street? Obviously, there is only one true answer to this question.
Support and resistance will form when large orders from buyers or sellers appear in the market. The reason that support will often repeat itself is because of the sheer volume of buy orders there are at that level. In other words, if you see $25 billion in orders in the 1.30 – 1.3010 zone all $25 billion of those orders have to be taken out of the marketplace. In other words, all of those orders have to be stopped out or closed. This takes a significant amount of sell orders needless to say, and because of that, it will often hold up. Also, you must remember that other traders are aware that these areas are out there, and they want to join in the move. When price pulls back to that level, they feel that they have a chance to profit from the area. Of course, the opposite is true about resistance: sellers are there in volume, and it takes a lot of buy orders to clear them out.
Now that we have established the trend, and we know which direction the market favors, we can begin to make educated decisions about the flow of money from one country to another. (The essence of FX trading.) For example, the GBP/CAD has been in a downtrend for some time. Knowing this, we want to sell Pounds against the Canadian dollar. We want to look for places that were once support, but have given way to the sellers. When these areas get retested, they will often turn into resistance. You can think of it like a high-rise building, if you are on the 14th floor, and drop down one level – you we standing on the floor that is now your ceiling. You will see this over and over in the FX markets. Take a look at this chart and notice how this played out over time:
You can see that at all of the breakdowns, price came back to retest it for resistance. Knowing that this happens time and time again, and that the market favors continuation of the trend, we can begin to make wise trading decisions. As a side note, further pushing for this simplistic analysis is the fact that markets tend to trend for 3-5 years at a time. This can lead to massive profits over time, but you have to be one thing most traders aren’t: patient.
You have to have the patience in order to only trade where it matters, and in the direction that matters over time. Have you ever looked at a chart like the EUR/CHF over the last few years and asked, “Why didn’t I just sell over and over again, it looks so easy!” That’s because it is. You have to be willing to wait for the market to give you clear and concise signals to enter in the direction it wants to go. One of the most famous traders of all time, Mr. Jesse Livermore once said, “In the marketplace, we get paid to wait.” This is what I believe he meant buy this statement. There are times when there is nothing going on in the markets, and as a trader, you have to be able to accept that. If you are patient enough however, you can place trades in areas that will offer fairly steady profits.
If you start with this very basic foundation in your trading, you will find it makes the indicators that you choose much more effective when used in conjunction. However, you may also find that you may choose to forego those indicators altogether.