[SECTION 1.3]
Technical Analysis: Trends, Support and Resistance
Charts, charts and yet more charts. When most people start trading the forex, they think about watching price movements flash by them on the charts and making money as they dip in and out of profitable trades. And it is here where traders show whether they have what it takes to be successful in the forex market.
Technical analysis, or chart reading, is the next natural step you can take once you have done your fundamental analysis. Fundamental analysis helps you determine whether you should buy or sell a particular currency pair.
Technical analysis helps you determine when you should buy or sell that currency pair.
Many traders consider technical analysis to be something of an art form that anyone can master with time and practice. To get started, you should focus on becoming comfortable with the following basic concepts of technical analysis:
- Trends - where prices may be going [SECTION 1.3.1]
- Support and resistance - where prices may stop and turn around [SECTION 1.3.2]
[SECTION 1.3.1]
Trading with the trend
The key to making money in the forex is identifying a trend and trading with it.
Trends tell you where prices will most likely be going. If the trend of a currency pair is pointing up, you need to buy the currency pair to make money. If the trend of a currency pair is pointing down, you need to sell the pair to make money. If the trend of a currency pair is pointing sideways, you either need to alternate between buying and selling or waiting until the trend points up or down to make money.
Whatever you do, never fight the trend. It is a battle that you won't win.
Trends do not move straight up or straight down. They usually move in one direction for a while and then retrace part of the previous movement before turning back and building momentum again. Every time a currency pair turns around and begins moving in the opposite direction, it forms a new high or a new low.
New highs form when a currency pair moves higher and then turns around and moves lower. New lows form when a currency pair moves lower and then turns around and moves higher. Identifying these highs and lows allows you to identify whether a currency pair is in an uptrend, a down trend or a sideways trend.
Up trends: These are currency pairs that are trending upward and form a series of higher highs and higher lows (see Figure 1).
Figure 1-Up Trend
Down trends: These are currency pairs that are trending downward and form a series of lower highs and lower lows (see Figure 2).
Figure 2-Down Trend
Sideways trends: These are currency pairs that are trending sideways to form a series of highs that are at around the same price level and a series of lows that are at around the same price level (see Figure 3).
Figure 3-Sideways Trend
Trends?be it up trends, down trends or sideways trends?can form over various time periods. Identifying the following trends over each time frame and being able to work them into your analysis is crucial to your success as a forex investor:
- Long-term trends [SECTION 1.3.1.1]
- Intermediate trends [SECTION 1.3.1.2]
- Short-term trends [SECTION 1.3.1.3]
- Aligning trend time frames [SECTION 1.3.1.4]
[SECTION 1.3.1.1]
Long-term trend
Fundamental factors are the major drivers of a currency pair's long-term trend. Now that you understand the impact that interest rates have on an economy's currency, you are already one step ahead of the competition.
You'll learn even more about the fundamental factors that drive long-term trends later. For now, all you need to focus on is how to identify long-term trends.
Long-term trends, sometimes called major trends, are those trends that have dominated a currency pair for the longest period. Take this chart of the EUR/USD. You can see that the currency pair has been rising in an up trend from left to right. Notice the series of higher highs and higher lows as time progresses (see Figure 4).
Figure 4-Long-Term Trend
Seeing this price action should spur you toward buying the EUR/USD. If the currency pair had been in a long-term downtrend, you would have a bias toward selling the EUR/USD.
Next, you need to look at the intermediate trend to see if it is trending in the same direction as the long-term trend.
[SECTION 1.3.1.2]
Intermediate Trend
Intermediate trends, sometimes called minor trends, are more responsive than long-term trends as they cover a shorter period of time. These trends are also affected by fundamental factors.
But interest rates do not dominate intermediate trends like they do long-term trends. Other fundamental factors carry equal weight in their effect on intermediate trends.
Looking at this chart of the EUR/USD, you can see that the currency pair was in a sideways intermediate trend during the highlighted time frame. Notice the series of level highs and level lows as time progressed (see Figure 5).
Figure 5-Intermediate Trend
While the intermediate trend was moving sideways, the long-term trend was still moving upward. Trends tend to move in a stair-step fashion. It's rare to see them move straight up or straight down.
Seeing this price action should confirm your bias toward buying the EUR/USD,as you think the currency pair is going to move higher. But, bullish though your long term outlook may be, you may want to hold back from buying the currency pair until you see the intermediate trend move upward, in line with the long-term trend.
Next, you need to look at the short-term trend. Whichever way it is trending will have implications for your decision-making process
[SECTION 1.3.1.3]
Short-term trend
Short-term trends, sometimes called micro trends, are more responsive than both long-term trends and intermediate trends as they cover the shortest period of time. These trends are the most volatile and are predominantly affected by news of the day.
It is not uncommon to see these short-term trends change direction with great rapidity.
Looking at this chart of the EUR/USD, you can see that the currency pair was in a down-trending short-term trend during the highlighted time frame. Notice the series of lower highs and lower lows as time progressed (see Figure 6).
Figure 6-Short-Term Trend
While the short-term trend was moving downward, the intermediate trend was still moving sideways and the long-term trend was still moving upward. As this shows, it is possible to have each trend moving in a different direction.
Seeing this price action should alert you to the possibility that your bias toward buying the EUR/USD in the future may, at least temporarily, not be correct. But don't panic. Since it is the only short-term trend, you should not abandon your bullish convictions toward the EUR/USD just yet.
In this example, the long-term, intermediate and short-term trends for the EUR/USD are in conflict. You should not trade when trends are at loggerheads. A wait-and-see attitude is the best option at least until you can align the trends from each time frame.
[SECTION 1.3.1.4]
Aligning trend time frames
Your most profitable trading opportunities will come when the long-term, intermediate and short-term trends all line up in the same direction. When the long-term, intermediate and short-term trends are all moving higher, it is an excellent time to buy the currency pair. When the long-term, intermediate and short-term trends are all moving lower, it is the right time to sell the pair.
You can see in the chart of the EUR/USD that the trend for each time frame has been moving higher for the past few months, and the EUR/USD has shot higher. Had you purchased this currency pair and held it through this most recent rally, you would have made a large profit (see Figure 7).
Figure 7-Aligning Various Trend Timeframes
Understanding trends is only half of the basic technical analysis picture. To complete the picture, you also have to grapple with the concepts of support and resistance.
[SECTION 1.3.2]
Support and resistance
Your trading profitability will be boosted once you can accurately identify levels of support and resistance. These are areas where prices may stop and turn around in the future.
Knowing where a currency pair may stop and turn around helps you enter and exit your trades at the most apposite times.
Support is a price level at which a currency pair tends to stop moving down and then turns around and starts moving back up.
Extra Material / Cut Outs
Support levels illustrate important psychological levels in the forex market. Support levels form because of the following:
- Forex traders who missed an earlier buying opportunity decide it is a good time to get into the trade
- Forex traders who bought the currency pair decide it is a good time to add to their positions
- Forex traders who sold the currency pair decide it is a good time to take profits
Resistance is a price level at which a currency pair tends to stop moving up and then turns around and starts moving back down.
Extra Material / Cut Outs
Resistance levels illustrate important psychological levels in the forex market. Resistance levels form because of the following:
- Forex traders who missed an earlier selling opportunity decide it is a good time to get into the trade
- Forex traders who sold the currency pair decide it is a good time to add to their positions
- Forex traders who bought the currency pair decide it is a good time to take profits
Support and resistance levels are not precise price points so can not be objectively defined. Rather, they are general price ranges.
For example, you are only going to frustrate yourself if you try to pinpoint a price level of 1.4225 on the EUR/USD as support. You will be much better off if you identify a price range of 1.4210-1.4240 or 1.4220-1.4230 as support. It's much better to give yourself room for manouevre. Make sure your support and resistance level ranges are flexible.
You will find that support and resistance levels come in varying forms. To become a successful forex investor, you will need to learn to recognise the following:
- Horizontal support and resistance [SECTION 1.3.2.1]
- Diagonal support and resistance [SECTION 1.3.2.2]
[SECTION 1.3.2.1]
Horizontal support and resistance
Horizontal support and resistance levels are perhaps the easiest levels to identify.
As you look at the charts of the currency pairs you are interested in trading, you will begin to notice that the currency pairs will often rise and fall to the same price levels before turning around and moving back in the opposite direction. These price levels are horizontal support and resistance levels.
Looking at the EUR/USD chart, for example, you can see that certain price levels (indicated by bold red lines) acted as strong levels of support and resistance. During 2006, the EUR/USD bounced back and forth between a support level at about 1.2500 and a resistance level at about 1.2900 (see Figure 8).
Figure 8-Horizontal Support and Resistance
Imagine you had bought the EUR/USD at 1.2500 as it was bouncing off of support and it was now approaching 1.2900. Knowing that this level has been a significant resistance level, you may look to exit your EUR/USD trade so you can realise your profits before the currency pair turns around and begins moving lower.
Once you feel comfortable identifying horizontal levels of support and resistance, you can move on to diagonal levels of support and resistance.
[SECTION 1.3.2.2]
Diagonal support and resistance
Diagonal support and resistance levels can be more difficult to identify at the outset. However, diagonal support and resistance levels are usually the most important levels when you are analysing a currency pair that is trending. Remember, you want to find trending currency pairs because it is much easier to make profitable trades when a currency pair is trending.
As you look at the charts of the currency pairs you are interested in trading, you will begin to notice that currency pairs will often rise and fall in a stair-step pattern. These patterns form higher highs and higher lows or lower highs and lower lows. The lines that connect these highs and lows are your diagonal support and resistance levels.
Looking at the EUR/USD chart, for example, you can see that the currency pair was creating a series of higher highs and higher lows through most of 2006 and 2007. If you connect all of the highs with a diagonal line and all of the lows with another diagonal line (indicated by bold red lines) you will be able to see the diagonal levels of support and resistance that are affecting the EUR/USD (see Figure 9).
Figure 9-Diagonal Support and Resistance
If you were watching the EUR/USD, you would have waited until you saw the currency pair drop down to the uptrending support level before buying it. Once you were in your trade, you could then watch for the EUR/USD to climb up to the uptrending resistance level before exiting the trade and taking your profits.
The key to effectively investing using support and resistance levels is to combine both horizontal and diagonal levels in your analysis. Your currency charts have a wealth of information locked within.
It's down to you to unlock that data with simple, effective, technical analysis techniques. | 
