Think of technical analysis as a telescope that can provide a large amount of relevant information in one digestible image. The power of technical analysis offers traders a much broader view of price trends than would otherwise be available to them. This will never mean, of course, they will get a clear picture of the future, because many unknown and unpredictable elements emerge all the time that can end up impacting the price of your chosen CFD trading instrument. What technical analysis can do, however, is help traders perceive patterns in an instrument’s price movement that might give them an inkling of what could happen next. This is presuming they are also staying in touch with world and financial news and are well-informed about their trading instrument. Let’s unfold three of the most widely used methods of technical analysis for those readers with an interest in CFD and forex trading.
Candlestick Charts
These powerful little tools are very commonly used in financial trading. The body of each candlestick on the chart represents the story of an instrument’s share prices for a period of time – often one day. The price fluctuations for that day remain within the range of that candlestick-shaped rectangle. A black candle means prices opened at the tip of the candle and closed at the base. A white candle means prices opened at the base and closed at the tip. The “wicks” above and below the candle – which are called shadows – show the extent to which prices ranged above and below the opening and closing prices during the session.
Traders are interested in viewing a series of candlesticks that display price activity for up to four weeks, so they can see larger price trends at work. An example of an eyebrow-raising pattern is a Morning Star. Here, the first candle in a series is long and black; the second (either white or black), is short and begins below the first one’s base; the third is a bullish white candle that extends up into the territory of the first candle. Candle number two tells us the selling sentiment of the previous session is settling, and the return to bullishness is confirmed by candle number three. Here, traders may see an opportunity to open a “buy” deal in this pattern.
MACD Indicators
MACD stands for Moving Average Convergence Divergence. These are a clever way of getting an idea of any changes in momentum that share prices might be undergoing. If you analyzed a basketball moving upwards at a slower and slower pace, you’d be able to figure out when it would stop and fall back down. Similarly with share price movements: If they’re going upwards at a slower and slower pace, we can deduce they could come to a halt at a certain point and then drop back down. Once analysts tune into these signs of slowing momentum, they have a chance of perceiving when, for instance, a downtrend is around the corner, so they could open a “sell” deal on the stock prices.
The method used to measure momentum is by comparing the 12-day moving average for the instrument with the 26-day moving average. To make use of MACD indicators, you won’t need to become a mathematician. Your trading platform should make the process fairly straightforward for you.
Fibonacci Retracements
These may be the most interesting of all. They’re based on the assumption that people’s trading behaviour is part of nature, just like galaxy formations and seashells. The same ratios underlying these spiral patterns in our universe underly the stages in human beings’ relationships with trading instruments, or so the theory goes. The key percentages determining the structures of naturally forming spirals are 23.6%, 38.2%, 61.8%, and 78.6%. These are the points in price reversal patterns when traders pause before deciding whether the instrument will continue with the reverse trend behaviour, or turn around and restart the original trend.
Practically, the Fibonacci levels are used in the following way: Your price chart shows a steep decline over the course of a month, after which prices start to recover for a week and then plateau. You draw horizontals on your chart at the peak of the trendline (before the decline began) and the bottom (where prices stopped sinking) and at the Fibonacci percentages. Now you find out that the plateau happens at the key level of 38.2%. That means rising prices slowed down when they had made up 38.2% of the original decline, and then stalled. In the two weeks following, prices sink back down again sharply. Many traders would open a “sell” deal at this point because, since prices stalled at a Fibonacci point and then continued down, as it seems traders were only giving a second thought to their course of selling before confirming it.
Summing Up
It’s advised readers take this overview as a springboard to further study of all three of the methods mentioned. There are many different ways each forex technical analysis method can be employed, many candlestick patterns to learn, and many exceptions to be aware of, too. After you’ve expanded your reading, you will have the equipment to significantly reinforce your forex trading strategy.
