Japanese Candlesticks

What are Japanese Candlesticks?

A Japanese Candlestick is a price plotting technique that offers a quick and easy method of identifiyin the price movement of a currency pair. This “at-a-glance” technique has been used in Japanese for hundreds of years and has only recently come to the West. Most Forex traders use candlesticks for price predictions because it quickly shows the strength and action of the bulls and bears over the price of a currency pair.download (1)

There are actually two ways to use Japanese candlesticks. The first way is to read the display of data in the individual candlestick. The second method is to the pattern identification process of using candlesticks in particular combinations. This tutorial focuses only on the information obtained from an individual candlestick. You will see that an individual candlestick provides a huge amount of useful information to the Forex trader.

Parts of a Japanese Candlestick

The Body is the thick part of the candlestick. It represents the range between the period’s opening and closing prices. The positions of the opening and closing prices will change depending on whether the period was bullish or bearish. If the body is white or clear, the currency pair experienced a bullish period. If the body is black or filled, the currency pair experienced a bearish period. The length and width of the body will change every trading period.

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The Shadows are the thin lines above and below the body. They represent the high and low prices for the period. The length of shadows will change every trading period. Sometimes there will not be any shadows. Other times, there may not be a shadow above or a shadow below the body.

 

Support and Resistance

One of the most important areas I often reference on the Forex Blog are support and resistance levels as “tactical points of interest”.

Support levels are potential “demand” areas where the price is often given to find support as it is declining.

This means the price is more liable to “rebound” off the level instead of pushing through it – all things being equal.  However, once price has passed through the level, by a significant degree it is often likely to continue falling until the next demand level.  A decline beneath a support level is often indicative of a new readiness to sell by the market participants or a lack of motivation to buy until price moves lower.

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Resistance levels are potential “supply” areas where the price is often given to find resistance as it is rising.

This means the price is more liable to “rebound” off the level instead of pushing through it.  All the same, once price has passed through the level by a considerable amount it often has the potential to continue rising until the next supply level.

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The following areas can all be used as support and resistance and are closely watched by price action forex traders:

  • Horizontal price support and resistance
  • Fibonacci retracements and projections
  • Floor trader Pivots,
  • Trend lines
  • Moving averages

This article will focus on the horizontal support and resistance elements.

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How reliable is support and resistance?

One factor to keep in mind when trying to determine support and resistance levels is that it does not always happen precisely at exact numbers (although it can sometimes!).

There can be a short term imbalance, which results in a spike through an area, and novice forex traders sometimes mistake this for failed support and resistance after a subsequent reversion to the recent range.

Chart time and experience helps us make discretionary judgement calls on whether a fake out/spike is taking place or if the area has been broken with reference to the time frame we are trading.  Other factors like the volume traded at a level can help with this analysis on other asset classes but not with forex.

Here are some of the key points I note when looking at a potential support or resistance level:

  • How many touches does the level have?  The more (accurate) touches the more interested I am in the level, as it will likely have caught the attention of other traders and potentially have the associated order flow.
  • How big were the previous bounces off the level.  The more pronounced the better.
  • Did this level form over a recent trading session or a while back?  More recent levels capture my attention but older levels are also noted.  I prefer to look from the right hand side of the chart and draw technical levels accordingly.

Price flip areas – Support becomes resistance and vice versa

Another rule of technical analysis states that support often turn into resistance and vice versa.

After price breaches support, the level can turn into resistance.  A penetration of support often indicates that the pressures of supply have overcome the inherent demand at a given level, so when price returns to the area there is, in all probability, an increase in supply so we now have resistance…

If we really think about it this makes perfect sense.  Fear and greed rule all markets, including Forex, and this is a great example of why.

Imagine you just bought a serious amount of euros and price went against you…  You are potentially holding a huge losing position and it doesn’t feel good.  You bought the euros at a clearly defined support level and wish you never did.  Then, just as you think the trade will hit your stop loss, the euro rallies and moves towards the original entry point.  The euphoria of seeing your hard earned money come back is overwhelming and you think yourself lucky to get away without a loss, close the trade at the previous support level, and breathe a sigh of relief.

While observing charts we sometimes forget what is actually behind every movement in price – people move price!

If this is happening on a large scale (the market) with many traders doing the same we create a resistance level as supply has increased – you create supply when closing the trade.

While observing charts we sometimes forget what is actually behind every movement in price – people move price!

Support has become resistance!

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With practice and chart time, you should be able to see potential support and resistance areas and plan your strategy around them accordingly.

It is our opinion that the best trade entry and exit strategies usually combine support, resistance and price action.

Trend lines

Trend lines

Trend Lines are an important tool in technical analysis for both trend identification and confirmation. A trend line is a straight line that connects two or more price points and then extends into the future to act as a line of support or resistance.. These lines are used to clearly show the trend and also help in the identification of trend reversals.

A trend line may be classified as:

  • Rising trend line or uptrend line
  • Declining trend line or downtrend line
  • Sideways trend line

 

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What is Market trends ?

A market trend is a tendency of a financial market to move in a particular direction over time. Trend is the most important concept in technical analysis. A trend designates the general direction of a market movement. It is important to identify trends so that you can trade with them rather than against them.

Types of Trend

A trend may be:

  • Upward – this is called a Rally ; the market trends the way up
  • Downward – this is called a Downtrend ; the market trends the way down
  • Sideways / Horizontal – this is called “flat market” or “trendless” ; the market trends nowhere

Trend Lengths

A trend of any direction can be classified according to its length

  • Short-term Trend ; it usually lasts no more than three weeks
  • Intermediate Trend ; it usually lasts somewhere between 3 weeks to several months
  • Long-Term or Major Trend ; it is considered to last for a year or more. It is composed of several intermediate trends, which often move against the direction of the Major Trend

Forex Market Analysis

There are three basic types of market analysis:

  1. Technical Analysis
  2. Fundamental Analysis
  3. Sentiment Analysis

There has always been a constant debate as to which analysis is better, but to tell you the truth, you need to know all three.

 

Fundamental Analysis

Fundamental Analysis is a way of looking at what’s happening with the currency from an economic point of view, mainly. As mentioned before, economic news is normally scheduled to be released at pre arranged times, as shown on the Forex Calendar. These announcements often move price.

Technical analysis

Technical analysis is the framework in which Forex traders study price movement.

The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement.

The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price. If price reflects all the information that is out there, then price action is all one would really need to make a trade.

Sentiment analysis

Sentiment analysis is a type of forex analysis that focuses on identifying and measuring the overall psychological state of all participants in the market. Sentiment analysis attempts to quantify what percentage of market participants are bullish or bearish. Once the majority sentiment is identified, a sentiment analyst will often take up a position on the opposite side on the assumption that the crowd is wrong.

How do you trade Forex?

In the Forex market, you buy or sell currencies.

Placing a trade in the foreign exchange market is simple: the mechanics of a trade are very similar to those found in other markets,  so if you have any experience in trading, you should be able to pick it up pretty quickly.

The object of forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold.

Example: You have 5000$ Account.
You estimate that the Euro will rise at price versus Dollar.
In that case, if you buy euro against dollar you will gain profit.

The main aspects of Forex market

 

The currency quotation is the cost of the currency expressed in another one (i.e. it shows how the current currency is more expensive than other / in our example on EUR/USD at the quotation of 1.3100 it will show that the EUR is 1.31 times more expensive than USD);

The currency quotations given by brokers usually looks like:

1.3100/1.3103 -this are Bid/Ask prices.

Bid — sell price (You can sell the currency pair at this price)
Ask — buy price (You can buy the currency pair at this price)
Spread — difference between the sell and buy prices (1.3103 — 1.3100 = 0.0003, or 3 points (3 pips))
Lot — the minimum operation value of standard trade contract.
1 lot — 100.000 basic currency (in our example it will equal 100.000 EUR)
0.1 lot — 10.000 basic currency (in our example it will equal 10.000 EUR)
0.5 lot — 50 000 basic currency.
Point (pip) — The minimal change of the currency pairs price.
1 point — 0.01 cent
1 point — $0.0001

Benefits of Forex Trading

Benefits of Forex Trading

 

Market Liquidity and Volatility

  • The forex market is the largest and most liquid of the financial markets.
  • Daily activity often exceeds $4 trillion USD a day, with over $1.5 trillion of that conducted in the form of spot trading.
  • Forex spot trades consist of a contract to trade a given amount of a currency pair with a market-maker, at the advertised buy / sell price (the spot rate).
  • It is the existence of volatility within the forex market that enables trader’s to take advantage of exchange rate fluctuations for speculative purposes.
  • Traders must be aware that greater volatility also means greater risk potential.
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Market Hours and Liquidity

  • Forex trading operates 24 hours a day, five days a week. The greatest liquidity occurs when operational hours in multiple time zones overlap.
  • It is important to understand the correlation between liquidity and market activity.

Low Cost of Forex Trading

  • The cost to trade with most forex brokers is the spread. This is the difference between the bid and the ask price.
  • Spreads in the forex market also tend to be much less (or tighter) than the spreads applied to other securities such as stocks. This makes OTC forex trading one of the most cost-effective means of investment trading.

Advantages of Margin-Based Trading

  • Most OTC forex brokers offer margin-based trading accounts.
  • Margin-based accounts differ from credit-based accounts in that when trading in a margin account, you must first open an account with your broker, and thenfund the account by depositing money into the account.
  • Once you have funded a margin account with your broker, you can engage in any trading activity you wish so long as you have sufficient margin remaining in your account.
  • Leverage makes it possible for you to trade larger positions than would otherwise be possible based on your actual account balance.
  • This means that leverage can provide greater potential for returns.
  • The downside of course is that there is also greater potential to lose money and you can incur significant losses in your account very quickly.

 

Potentially Profit Regardless of Market Direction

  • A short-sale – or simply a short – is the selling of a currency pair before you buy it.
  • It is very easy to enter into a short-sale when trading in the forex market.
  • In order to make a profit on a short, you must buy the currency back for lessthan you received when you sold it. The difference represents your profit or loss.
  • The ability to engage in short-selling means that it is possible for you to profit no matter which way the market is trending.
  • When rates are increasing, you can earn a profit if you buy (go long) a currency pair, and then sell it later for more than you paid.
  • When rates are falling, you can earn a profit if you sell (go short) a currency pair, and then buy it later for less than you earned when you originally shorted the currency pair.

What is Currency Pair?

Currency Pair

Two currencies are always involved in a forex trade – one is being bought in exchange for the other. Together, those two currencies are called a currency pair, and are usually represented as two three-letter currency abbreviations. For example, consider the currency pair EUR/USD. In this example, the first currency, the Euro (EUR), is called the Base Currency and the second, the US Dollar (USD) is called the Quote Currency.

For most transactions, either the USD or EUR is used as the base currency. In the case of the example EUR/USD, the value of the USD (the quote currency) is considered in relation to 1 EUR. If the quoted price for this pair is 1.3553, this means that 1 Euro can buy 1.3533 US Dollars.

Here is how that information might be used. If a trader thinks that the value of the US Dollar will decrease in value relative to the Euro, he might buy the EURUSD, currency pair and then later sell the pair for a profit when the value of the pair increases (representing a decrease in the value of the USD, the quote currency) See below for a detailed example of a similar trade.