By Adinah Brown
To the novice trader the ups and downs of the market look fairly undecipherable, but the more you become acquainted with the vicissitudes of the market, the more easily understandable the charts become. Stay around a bit longer, and the time it takes to read the charts gets exponentially faster. For now, we’ll take you through the basics of trading fx to hopefully give you a strong head start.
Japanese Candlesticks
A nice name for a nice chart, the candlestick basically takes the information shown in the bar chart and puts the open / close values in a box. With the high / low being displayed at the end of an attached line, looking like a wick at the top, it is visually reminiscent of a candlestick (or, I suppose, a stick of dynamite).
Japanese Candlesticks are useful for visualizing trend directions simply, so that if a security has increased in value in the course of a period, it is colored green and if it has decreased in value it is red. It is also useful for determining volatility or trying to visualize support and resistance points, as the candlestick will show how often the levels are tested in a more detailed way than other charts.
Periodicity
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The other component for setting the chart is the time frame, or periodicity, where the trading platform will provide various intervals. The different options simply reflect the timeframe of each candlestick . Put simply, a five minute chart will show the trading period from open to close over 5 minutes, whilst a minute chart will show the open and close difference over 1 minute.
The periodicity when setting the charts should reflect the trading timeframe of your strategy. For someone that is looking to trade a short term timeframe, the periodicity needs to reflect the short timeframe needed. Same for a longer timeframe. There is limited value in a long term buy and hold trader using a 15 minute chart, as it won’t show the trend to reflect good entry and exit points.
With periodicity, it is often useful to have two different periods in play. The first should be to determine the entry/ exit point of the trade, whilst a second, often longer periodicity, should be used to get a different perspective of the trade, to understand the broader trend.
Chart setup should allow you to undertake your strategy and give you the visual tools to make the best trading decisions.
Going back to our Japanese Candlesticks, let’s take a look at particular trading methods. With their bizarre sounding names of hanging man, hammers, inverted hammers or shooting star, we demonstrate how these strategies can be used to show reversals and how they often comprise the basis of trading entry and exit points.
Shooting Star
This candlestick formation results when a security’s price at some point during its periodicity advances well above its opening price, but then closes lower than the opening price. This formation necessitates an upward trend, where the distance between the highest price for the period and the opening price must be more than twice as long as the shooting star’s body. In contrast, the distance between the lowest price for the period and the closing price must be very small, if not non-existent.
Hanging Man
In contrast to the shooting star, a hanging man, reflects a bearish candlestick formation that will occur at the end of an uptrend. It develops when there is a large sell off shortly after the new period opens, but buyers are quickly able to push this security back up so that it closes not too far off from its opening position. The large sell-off is often seen as an early indication that a bullish trend is waning and further demand for the security is drying up.
Hammers
The hammer is where a price pattern forms when the traded security drops immediately after its opening, but rallies upwards in the period to close either above, or at least near, the opening price. The results is a hammer shaped candlestick, where the body is a good half length longer than the tail or the wick.
A hammer is indicative that a security has been declining and that the market is attempting to determine a new bottom threshold. While the signal doesn’t necessarily indicate that bullish investors have taken full control of a security, it may be indicative that a bullish trend is strengthening.
RSI Indicators
An acronym for Relative Strength Indicator, this momentum indicator compares the magnitude of recent gains and losses over a specific period of time and thereby measures the speed and change of price movements of a particular security. It is commonly used by traders to identify when the market is overbought or oversold for a particular asset.
The RSI is widely used and a popular tool for traders because it provides a quick and easy evaluation of the strength of a security’s price performance, by comparing the up periods to down periods, effectively making it a momentum indicator.
The RSI provides a value that ranges from 0 to 100 which is issued every 14 days. RSI values of 70 or above are indicative that a security is becoming overvalued and overbought, the implication of which means that the asset may be prime for a corrective pullback in price, at which point the market will experience a trend reversal. On the flip side an RSI reading of 30 or below is indicative of an overvalued or oversold security, which will be interpreted that a corrective upward price reversal is likely.
About the Author:
Adinah Brown is a professional writer who has worked in a wide range of industry settings, including corporate industry, government and non-government organizations. Within many of these positions, Adinah has provided skilled marketing and advertising services and is currently the Content Manager at Leverate.