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5 Technical Analysis Tools to Transform your Trading

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Written by FXTM Senior Staff Writer, Ben Lovell-Viggers

In trading, it pays to be informed. That’s why traders gather as much information they can before making a decision. Researching the political and economic factors that can affect markets is known as Fundamental Analysis, while reviewing price charts and technical indicators for the purpose of identifying trends in their early stages is called Technical Analysis.

Both methods of analysis have their benefits and applications; however, Forex traders are strong believers in the value of technical analysis because it can reveal short-term price movements. Why not give your own trading a boost with these five top technical analysis tools?

 

Japanese Candlesticks

What is it?

Japanese Candlesticks are a pictorial method of price charting, invented in Feudal Japan by a rice trader named Munehisa Homma and brought to the West’s attention by Steve Nison. Legend tells that Homma carried out one hundred successful subsequent trades thanks to his use of Candlesticks.

What’s it used for?

Japanese Candlesticks’ design allows them to divulge information about market direction, pricing extremes and even investor sentiment in a simple and easy-to-interpret format.

How does it work?

Japanese Candlesticks come in two forms. Candles with a white or hollow body indicate that there is more buying than selling interest; therefore, the market is moving up and market sentiment is positive. Black candlesticks, or those with filled bodies, represent negative market sentiment – the market is moving downwards and there is more selling than buying interest.

 

Moving Average (MA)

What is it?

Moving Averages are a variety of trend-following indicators and some of the most commonly used tools in technical analysis. There are many different forms of Moving Average, but the most popular are Simple Moving Averages (SMAs), Exponential Moving Averages (EMAs) and Weighted Moving Averages (WMAs).

What’s it used for?

Moving Averages are employed by traders to smooth out the volatility in price charts. Filtering out the ‘noise’ of random price anomalies makes it simpler for traders to identify trends and price direction.

How does it work?

Moving Averages are calculated by adding the closing price of a financial instrument over a number of time periods, then dividing the total by the number of time periods used. Moving Averages covering different time frames can also be compared to identify uptrends and downtrends in financial data.

 

Relative Strength Index (RSI)

What is it?

Relative Strength Index is a momentum indicator. It was developed in the late 1970s by J. Welles Wilder Jr., a mechanical engineer-turned-analyst who is responsible for developing many of the core analytical tools used by traders today.

What’s it used for?

RSI measures momentum, or the rate at which the price of a security rises and falls. This gives traders an insight into whether the asset is experiencing increased buying or selling pressure, and helps determine whether the asset is overbought or oversold.

How does it work?

Traders measure RSI over a fortnight using a scale of 0-100. The two most important number on this scale are 70 and 30. Scores over 70 indicate overbought conditions, while readings under 30 are considered oversold.

 

Bollinger Bands

What are they?

Bollinger Bands are a popular volatility indicator. They were conceived in the early 1980s by John Bollinger, one of the leading proponents of technical analysis.

What are they used for?

Bollinger Bands are commonly used to help traders identify advantageous trading opportunities; they do this by representing varying levels of volatility. Bollinger Bands work as indicators on the assumption that highly volatile conditions are always preceded by periods of low volatility, and vice-versa.

How do they work?

Bollinger Bands are intended to give traders a relative definition of ‘high’ and ‘low’. A Moving Average (SMA is the most commonly used, followed by EMA) is plotted alongside two flanking price bands. Low volatility conditions are indicated when the price bands converge on the central Moving Average, and vice versa.

 

Fibonacci Retracement

What is it?

Fibonacci Retracement is a method of technical analysis that has gained some public exposure through its use of the ‘Golden Ratio’, or Phi. Phi – 0.618 – is extracted from the differences between numbers in a Fibonacci sequence, the sequence formulated by legendary mathematician Leonardo of Pisa.

What’s it used for?

Fibonacci Retracement is used to determine an asset’s support and resistance levels. This allows traders to make ‘informed’ trading decisions. Because Fibonacci Retracement levels are static, they are easy to interpret at a glance. This makes Fibonacci Retracement particularly useful Forex, as traders are required to make decisions in a split second.

How does it work?

Fibonacci Retracement works by determining the distance between a financial asset’s high and low price. Support and resistance levels are then calculated by dividing the vertical distance between the high and low using Fibonacci ratios of 23.6%, 38.2%, 61.8% and 100%.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.


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