ART OF CURRENCY TRADING

Chapter 6: Understand Technical Analysis I

Does it work?
Technical Analysis is best used for risk management and tactical considerations (entry level,
stop loss, take profit, and position size) and not as a primary trade selection or forecasting
tool.
I. Main Branches of Technical Analysis
1. Traditional Technical Analysis:
This includes trend, breakout, cycles, retracements, momentum, support,
resistance, moving averages, overbought, and oversold.
2. Candlestick Charting:
This gives you a better view of the price action.
3. Elliot Wave and Cycle Analysis:
These are specialised, highly complex systems of analysis used by a limited
group of practitioners.

II. Choosing Indicators

When using technical analysis as a risk management and a tactical tool, simpler is
always better.

III. Basic Indicators

1. Support and Resistance:
This is the idea that the price will bounce off the same level more than once.
There are four explanations for the existence of support and resistance:
a) Large Limit Orders:
These are pockets of liquidity that can stop the market.
b) Self-fulfilling prophecy:
If there is an obvious support level, traders will tend to place their bids
ahead of this level and their stop below.
This works because people believe it will work.
c) Option-related:
If there is a large option in the market at a given level, it can create
support and resistance near there.
d) Round Number Bias:
Highs and Lows are more often made on round numbers.

IV. Using Support and Resistance in Your Trading

While the concept of Support and Resistance is simple, it can also be powerful.
 The first step when looking for support and resistance is to simply scan the
10 minutes, hourly, and daily charts and look for major bottoms and tops.
 The more times a level or zone holds, the more likely the market is
focused on it.

2. Simple and Exponential Moving Averages (Plus Crossover)

  A Simple Moving Average (SMA) is the average price of a security
over the past X number of periods.
 An Exponential Moving Average (EMA) is similar to an SMA but it
puts more weight on recent data versus old data.
 Generally, the 200-hour SMA is found to be the best moving average
in most currency pairs.
 Most common use of the MA are:
a) Use the MA as Support or Resistance.
b) Use a Crossover of 2 Moving Averages to trigger buy or sell
signals to define trend.
- A trader might focus on long positions only when the 20-
day MA is above the 55-day MA
- And focus on short positions only when the 20-day MA is
below the 55-day MA.
c) Use the Slope of a single MA together with its Location to
enter newly forming trends.
- When the price is above rising long and short-term moving
averages, it can be beneficial to jump in on the long side.
- When the price is below falling long and short-term
moving averages, the benefit may be on the short side.
d) Use closing prices with MA
- When the close is above MA, go long
- When the close is below MA, get short.
 MA are useful in Trending Market, and are Useless in Rangebound
Markets.
 If you can find a setup where you have a MA and a major Support
around the same level, this makes you levels much stronger.
 When multiple technical indicators come together near a single level, it
is known as a convergence.
3. Measuring Momentum, Overbought and Oversold
Most useful indicators: - MACD
- RSI
- Parabolic SAR
- Deviation

 They all try to identify when the price has extended too far, too fast in
one direction and could be ready to turn back around. (Price is like a
rubber band)
RSI & MACD
 Looking at the RSI, when the price gets above or below a certain level
(30 & 70 for example), the currency pair is oversold or overbought.
 You can also look for divergence between the price and the MACD or
RSI to determine when the trend is out of steam.
Parabolic SAR
 The Parabolic SAR “Stop And Reverse” indicator, is used to
determine the trend direction and potential reversal in price.
 A dot is placed above the price if it is trending downwards.
A dot is placed below the price if it is trending upwards.

4. Candlestick Charts
Most important aspects of candlestick charting:

A single Candle stick is not relevant. Instead, you need to look at groups of
candles in order to be able to identify known patterns.

Following are the most useful candlestick formations:

Dojis

 A Doji is a candle where the open and close are very similar, therefore
the body is tiny and the wicks are long (It represents indecision)
 These candles are especially important after a long trend as they
suggest a turn or rend change is possible.
 Hammer Candles

 A Hammer indicates aggressive price action and reversal at an

extreme and often predicts a trend reversal.
 It can show when uptrend buyers or downtrend sellers are
exhausted.
In the hourly chart, long wicks can indicate uncertainty if few are
fond in the same area.

5. Ichimoku Cloud
Ichimoku Cloud is a collection of technical indicators that show support and
resistance, levels, as well as momentum and trend direction.
 When the price is below the cloud, the trend is down
 When the price is above the cloud, the trend is up
 The trend signals are strengthened if the cloud is moving in the same
direction as the price.
V. Identify the Regime
You need to determine whether the current Trending or Rangebound Market is
likely to expire soon or to continue.
1. Rangebound Markets
Rangebound markets are the most difficult to trade:
 They are characterized by prices moving within a defined range
back and forth.
 The range is not always well defined.
 You don’t realise it is a range until it’s too late and the range is
ready to break.
 The strategy in rangebound market is to buy near the top and sell
near the bottom, which is not easy, as you need to bet against what
can sometimes look like important news + the range bound markets
are characterised by false breaks.
2. Trending Markets
There are two main ways to make money during trends:
a) Trade Pullbacks:
 Identify the trend, then simply pick a moving average and
trade the trend as it pulls back to it.
  A new trend is signalled by two moving averages when they
cross.
- If the faster moving average crosses up through the
slower one, that signals a new uptrend.
- When the fast-moving average crosses below the slow,
that signals the start of a down trend.
b) Trade Breakouts and Continuation Patterns
Identify one of the patterns below, and trade a breakout with a stoploss
of approximately (average daily * 1.5)
i. Flag Patterns:
 A strong trending move (large bodied candles) followed
by a weak pullback (small bodied candles) /=
 Best noticed after a breakout.
 Entry: Breakout above the high.
Stop Loss: 1 ATR below the low
Exit: Moving average or structure.
ii. Pennants:
 Are similar to flags but are triangular. />
iii. Triangle:
 Are similar to pennants but have no flag pole. >
VI. Reversal Patterns
Double and Triple Tops
This is self-explanatory.
Each time the same level prints as high or low, it gains more attention and
importance.