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Methods of technical analysis of the Forex market

Generally, Forex technical analysis is defined as the study of previous price dynamics to predict future patterns and trends. This approach is based on the hypothesis of the cyclicity of human behaviour. Usually, technical analysis of the Forex market makes it possible to make price forecasts with a fairly high probability of results.

There are a lot of technical approaches, from which each trader should find the most suitable for him, based on the chosen trading style. The greatest degree of immediate feedback is provided to the intraday trading period, which gives the opportunity to “keep the fingers on the pulse” and a willingness to take action if the forecasts are incorrect. As for the past situation, the technical analysis of the Forex market is quite informative, but at the same time does not give us absolutely any guarantees regarding the future price movement.

Oscillator analysis

Intraday trading requires constant monitoring of the market in the range and direction of the trend. If the market is trading in a range, then funds are needed to establish reversal short-term points. If the technical analysis of the Forex market indicates the development of a trend, then we need the means to establish (1) the appropriate entry points based on the current trend and its intensity, and (2) the appropriate exit points based on the potential subsequent depletion of this trend.

An effective means of determining short-term turning points is to assess the momentum, which is based on subsequent market fluctuations. A price impulse is a measurement of the speed or degree of price change. As a rule, if it is assumed that the subsequent market fluctuations will continue to form new highs or lows, it increases the likelihood of price increases along with movements to new highs or lows. If the Forex technical analysis indicates that the subsequent fluctuations do not have an increase in the momentum, then the reliability of any push above or below should be questioned.

One of the most effective tools for measuring price impulses, which contains in its Arsenal Forex technical analysis, is the Oscillator 3/10, which is based on the difference between the ten-exponential and three-period exponential moving. An alternative to most graphical programs is the construction of the MACD indicator. The 3/10 oscillator can be modelled with MACD, setting the parameters as follows: fast EMA to 3, MACD SMA to 1, and slow EMA to 10.

The use of the 3/10 Oscillator in the technical analysis of the Forex market is based on attempts to determine one of the two States of market fluctuations that will move to new highs (“oscillator Divergence”), or lows (“confirmation of momentum”). These two States are opposite to each other and each subsequent higher maximum or minimum of oscillations will necessarily be accompanied by one of these States.

If the market develops a trend to the lowest prices, the oscillator Divergence can be described as fluctuations to the new price lows, accompanied by a higher minimum in the oscillator. If the technical analysis of Forex shows that the market is developing a trend to the highest prices, this condition is described as fluctuations to new highs, accompanied by a lower maximum in the oscillator. The graphs show examples of these two States.

It can be seen from the charts that the Divergence of the oscillator indicates that the current market movement loses momentum and increases the probability of a reversal. If we consider trading in the direction of the upcoming reversal, the Forex technical analysis considers this time to be suitable for entering the market. At the same time, confirmation of the momentum indicates that the current direction of fluctuations has a certain strength and the trader needs to hold positions or look for an opportunity to enter in the direction of market movement.

If the 3/10 Oscillator is used properly, it can be a very useful tool for intraday trading. The 3/10 oscillator is a fairly fast and efficient tool for measuring market impulses and establishing the main direction of the market. But it should be borne in mind that this tool, like other tools, is not error-free.
HONEYCOMB or reference point System

Forecasts based on the analysis of impulses can be more effective if the levels acting as “price benchmarks” in the interpretation of the activity of the 1st trading day are pre-determined. At the same time, one of these approaches, which covers the technical analysis of the Forex market, is a system of reference points.

Traders who trade in the trading floor use similar systems to evaluate market instruments in the absence of external influences. This system sets relative price levels, which are based on the price activity of the previous trading day.

The HONEYCOMB price level acts as a potential support/resistance zone for one day. In addition, they serve as guidelines for professionals in the exchange hall. Outside the trading floor, traders can use these values to determine the appropriate areas to enter the market and open stop orders.

The following formulas are used to calculate the support/resistance level in HONEYCOMB:

DP = (H + L + C) / 3;
R = 2 * DP — L;
S = 2 * DP — H;
R’ = DP + (R-S);
S’ = DP – (R-S),

where DP is the Daily reference point (DOT), R and R’ are resistance levels above the DOT, S and S’ are support levels below the DOT.

The daily reference point is a fundamental level, which is regarded as a point of balance between the strength of bears and bulls. At the same time, the demonstration of a large price activity has a bullish value, and the activity below the DOT has a bearish value.

As a rule, technical analysis of the Forex market regards intraday trading activity as an attraction to the Daily reference point. At a time when the price moves away from this zone and approaches the first resistance level (R) or the first support level (S), the market behaviour becomes increasingly important. Each deviation from these achieved levels increases the likelihood of a return to the DOT. Violation of any of the initial levels of Forex technical analysis is regarded as a change in the evaluation of traded instruments.

Penetration through each next support / resistance level is interpreted as greater involvement of market participants. The increase in the number of participants implies a high probability that long-term positions will be disclosed, which will eventually lead to a greater potential for the continuation of the trend. Every next broken level of resistance or support of SOT Forex technical analysis is regarded as an increase in the number of long-term participants.

When there is a pronounced violation of the support or resistance level, it is considered that this level has changed its role of resistance to support or Vice versa. Subsequently, this level will become a test point for subsequent market activity, an example of which is shown in the graph on the right. This chart shows the price action that develops after the breakout up (R) – the first resistance level. When the price returns to this level, it is a test of its reliability. Testing with the help of Forex technical analysis is considered successful if the recovery movement turns and the price rushes up. This movement of the price increases trust to this level. Any subsequent movement from the level has a chance to go through other support/resistance levels, involving more and more long-term players and continuously expanding the range of market activity.

Support and resistance levels of HONEYCOMB are a useful tool for intraday trading. In order for the HONEYCOMB to be effective, it is necessary to measure intraday support/resistance levels quickly enough, as well as effectively set market activity benchmarks, which will allow a better understanding of market behaviour. These levels help to determine when and where short-term intraday trends will fluctuate, as well as serve as “test points” for forecasts about the future behavior of the market. Skillfully compiled technical analysis of Forex will help to make the right trading decision.

The indicator that automatically builds pivot Points can be downloaded at the end of the article.
Dynamic support and resistance

One of the major drawbacks of using honeycombs is that THEY are calculated based on the price activity of the previous day and are not able to accurately reflect recent changes in market behaviour. Effective intraday trading also requires funds to establish support/resistance levels, which are fairly easy to adapt and more accurately represent price activity when market conditions change. A 20-period exponential moving average (20EMA) can be used to form the more dynamic support/resistance levels. At the same time, the support / resistance levels of HONEYCOMBS during the day remain unchanged, and 20EMA changes according to changes in the price. This feature of the technical analysis of the Forex market makes the support/resistance levels a very effective tool, especially with significant changes in the market movement between the levels of HONEYCOMBS and after large impulse movements.

For example, most traders using Forex technical analysis as their main intraday chart use a five-minute time scale, often referring to other periods to confirm market conditions. In this case, the five-minute 20EMA is the Moving average, which is most often referred to. In addition to 5-minute, 15 – and 30-minute 20-period EMA are used for additional graphical analysis. This can be achieved as:

for a 5-minute 20EMA, a 20-period exponential moving average is formed,
for a 15-minute 20EMA, a 60-period sliding,
for the 30-minute 20EMA, a 120-period exponential moving average is formed, respectively.

It should be taken into account that the values for 15 – and 30-minute 20 EMA, which are obtained in this way, are not accurate, but are useful for establishing possible support/resistance levels.

20EMA is often considered as any other potential support or resistance level. If the market is characterized by a tight trading range, then these levels can be easily broken, but at the same time with the development of the trend 20EMA provides valuable assistance in identifying areas that can be considered for opening new and exiting existing positions. Applying technical analysis of the Forex market, it is necessary to take into account all factors that influence the development of the market.

When Forex technical analysis points to the continuation of a trend, the trader needs to look for opportunities to enter into a recovery movement that moves the price to potential support (if the trend is up) or resistance (if the trend is down). The first support/resistance level that the market encounters will probably be a 5 -, 15-or 30-minute 20EMA. It is necessary to observe these levels when the trend is expected to continue. When the trend is established, often one of these levels (usually five-minute 20EMA) will be quite effective to restrain the price movement.

After price shocks caused by important events, 20ema can enter the game. At the same time, trading conditions can be volatile, and at this time it is better to stay away. Usually, a strong impulse push accompanying such events indicates the establishment of a new trend. Such a price movement usually undergoes a recovery before it becomes stable. 20EMA’s ability to respond quickly to market changes makes it a very valuable Forex technical analysis tool.
Highs and lows of the previous day

All the methods of intraday trading described above refer to the levels obtained as a result of mathematical calculations. In contrast, the following technique deals with more explicit support/resistance levels. So, let’s consider the technique of applying the price extrema of the past day.

Using technical analysis of Forex, market activity can be represented as an auction in which buyers and sellers are constantly competing for the best price, the daily lows and highs of the previous period will be external restrictions on the value of the price for a certain trading day. The highest price reached during the 1st trading day is the maximum that buyers can offer for a particular item, and the lowest price is the minimum that sellers can accept. Thus, the next price action may remain within the limits of the obvious price values that were set during the previous day.

Under standard market conditions (all price spikes are driven by news, technical analysis of the Forex market considers an exception), violations of the highs or lows of the previous day are usually preceded by several unsuccessful attempts of violations. After a successful breach, the price action is an important change in market psychology and has the potential to form a new trend.

One of the ways to use this market scenario is to use the actual breakout of the minimum or maximum of the previous day as a signal to enter: when the maximum is broken, the opening of a long position and when the minimum is broken, the short position. Sometimes the use of this method of Forex technical analysis is the only possible way to participate. But keep in mind that this is quite an aggressive method and raids into new market areas can quickly unfold. As a rule, Forex technical analysis is most effective in calm, non-aggressive trading. A more conservative and less risky approach is to expect a pullback of the price movement. Short-term pullbacks often occur before the start of a trend movement. Most often, violations of the highs or lows of the past day are fully restored to the initial point of the breakthrough. If this does not happen, the next possible recovery level will be a five-minute 20EMA.

In addition, the technical analysis of Forex regarding the high and low of the past day can also be very useful when the market is in a narrow range for a long time. Such a scenario is often accompanied by a strong movement beyond the range and a sharp increase in variability. Sometimes the increase in variability can be sudden and strong, allowing for more profit, but only in the right direction of the breakout.

Each time when identifying the conditions of weak variability, the breakthrough of the highs or lows of the past day serves as a signal of movements from the range that will allow you to enter the market and participate in trading with a small risk.

There are several methods of Forex technical analysis, with which you can make a preliminary assessment of the potential direction of the breakthrough and perform an earlier entry. For example, you can determine the direction based on the price activity of the highs or lows of the previous day and the current DOT. If the market first approaches the minimum of the last day and then moves up through the DOT, then the most likely direction of the breakthrough will be to higher prices. Conversely, if Forex technical analysis shows that the market is approaching the maximum of the past day, pushes and moves down through the DOT, the most likely direction of the breakthrough will be to lower prices. Often the key to the likely direction of the breakthrough can be found in the market behaviour around the Dot. If the price can not break this level, the breakthrough will develop against this movement.

The highs and lows of the past day are extreme points of price values, they can act as support/resistance levels during the 1st trading day. Price dynamics near these levels can provide valuable information about the future situation in the market.

Usually, novice traders study the technical analysis of Forex, from the standpoint of the identification of a single trading method, system or indicator, which, with the exact execution of all requirements, in most attempts gives positive results. At the same time, it is important to understand that it is not necessary to evaluate a separate technical tool as a way of losing and winning. One and the same tool can bring profit to one trader, and to another only loss. All technical tools simply assist in trading, and it is necessary to select them, based on the style of trading and the chosen tactics.

So, Forex technical analysis quite effectively analyzes the situation in the past, but it does not give any guarantees regarding the development of the situation in the future.

All of the above methods are a step towards interpreting the price dynamics and driving forces of the market, but do not expect that they will lead to a successful trade. Some of these methods will be more effective, some less, it all depends on the market conditions and the experience of the trader. In order for the application of market instruments to be successful, considerable practice will be required. It is necessary to work long time with each tool and only after that it is possible to judge its advantages and shortcomings. Competent technical analysis of the Forex market will allow you to really assess the market conditions and draw conclusions on which the winning strategy will be based.