The first step in technical analysis is to learn to read the charts. This article discusses a few basic lessons to guide your early attempts.
When first analyzing a currency pair, look for the prevailing trend. Start with the long-term charts (monthly, weekly, and daily), going back for several years. These charts contain more data, which provides a clearer picture of what the currency pair is doing than short-term charts. The extra data also makes the information generated by the indicators more reliable.
Identifying a trend is simple: simply look at the chart and decide if the graph is going more up than down, or more down than up. Trends can be steep or shallow, years-long or weeks short. Practice identifying them, and finding points where they change direction. The longest-term trend is the strongest, which is another reason for reading these charts first.
Even if you’re scalping or day trading and don’t intend to hold a position longer than an hour, you’ll do better by trading in the same direction as the prevailing trend. So take the time to identify it on at least the daily charts before you begin. There’s an old trader’s saying: “The trend is your friend.” It’s not a lie.
Once you’ve identified the trend in the long-term charts, compare that with what you read in the short-term charts. You’ll find that there can be any number of intermediate-term and short-term trends within the path set by the prevailing trend. The graph will fluctuate up and down but overall it will follow the path set by the longest-term trend.
Next, find the support and resistance levels, which are the “floor” and “ceiling” points on the graph, respectively. These are key points on the chart where the price repeatedly refuses to break through, or just peeks through then gives up the fight. The price will go just so high or so low, but no further; it reaches that point then changes direction. The more times that happens, the stronger the support and resistance are.
Draw a straight line, either in your mind or on the chart, passing through most of the support points. Then draw another passing through most of the resistance points. This gives you a picture of the path the currency pair’s trend is following, called a price channel, and it’s a simple but powerful tool to help determine how that path will continue.
When support and resistance are strong, the graph of the currency pair seems to bounce along sideways between those two lines like a pinball. When this happens, the currency pair is said to be range-bound. As this happens 80% of the time, many people simply trade within channels, although this technique doesn’t deliver any jackpot profits.
These lines do not have to be level. Sometimes the currency pair is trending up or down, but still moving within that channel. Regardless of the way the channel is slanted, you can still trade within that range.
When a currency pair breaks out of a price channel, sometimes it falls back into the channel, and sometimes it gains momentum and keeps moving. This last is called a momentum market, and it’s the other way to trade the range: set an entry order for the price to break out, either above or below the channel, then sit back and let it ride.
Congratulations—you now understand the most important elements of basic technical analysis!