Chart analysis can be a bit daunting for novice traders.
Starting from scratch
There are so many different drawing tools and technical indicators to consider that it’s difficult to know where to start. As with anything new it involves learning a language with all the fresh terms and acronyms that follow. But it needn’t be overwhelming. The trick, as with anything unfamiliar, is to take things slowly enough to understand one term before moving on to another.
Perhaps the most important detail to establish when looking at a chart is whether the market under consideration is trending or ranging. If you can work this out with a decent degree of certainty then you have a good chance of at least being on the right side of a market move, even if you don’t buy at the lows or sell at the highs. Now there are technical indicators which will help you to establish this. The Directional Movement Indicator springs to mind. But you can often work out how a particular market is behaving just by looking at the chart itself and then drawing on a few sets of parallel lines to help identify areas of possible support and resistance.
Upward trend analysis
Here’s the EURUSD in the two years from mid-2012, an example of a market in an upward trend:
Downside trend analysis
And here’s a daily chart of the EURUSD showing what happened next:
Using horizontal lines
This shows the euro declining sharply until March 2015 (another trend, but this time to the downside) after which time it traded in a range. We can look at the behaviour of the currency pair in more detail and get an idea of the top and bottom of the range by drawing on some simple horizontal lines:
As we can see, the EURUSD has spent the vast majority of the last 22 months trading between 1.1450 and 1.0500. Of course we’re considering all this price action in hindsight, so arguably it’s of little value. However, we can see that this range actually established itself within a few months of the EURUSD hitting a multi-year low just below 1.0500 in March 2015.
In fact, we can see how the area around 1.1450 was already appearing as an area of resistance in the month prior to the March low.
Looking for opportunities
Here’s the period from March-December 2015 in more detail:
Now this is quite a wide trading range and while there are a number of shorting opportunities at the upper line of resistance, there were very few occasions when the EURUSD fell back to test support around 1.0500. As a consequence, this simple horizontal support line wouldn’t have been sufficient on its own to throw up actionable buy signals.
But it’s possible to look inside this range for other trading opportunities. We can draw a fresh horizontal line linking up a number of trading lows. This gives more trading opportunities and will also help us work out where best to place stops and limits.
As we can see, the range tightened up later in 2015:
Understanding breaks in resistance
Even within this trading range it’s possible to see the odd short-term trend emerge. But perhaps most importantly, it shows what can happen when support (or resistance) is broken.
The first area circled highlights what turned out to be a temporary break above resistance. The second shows where support was broken, then retested before failing leading to a month-long decline. This demonstrates two points: the first being the importance of careful risk and money management. The second is that events or changes in fundamental factors influencing market direction can often trump technical analysis. The downward trend in the EURUSD continued after the pair broke below support around 1.0800. But short-term direction reversed sharply in early December 2015. This was when the European Central Bank shocked markets by holding back from announcing plans for further monetary stimulus.
As we can see from this final chart which brings us up to date (January 2017), the euro rallied once again and briefly broke above resistance before pulling back to multi-year lows. Now we’ll see if the EURUSD goes on to make fresh multi-year lows or looks to hold within its two-year range.
Disclaimer: Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. This material has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. As a marketing communication it is not subject to any prohibition on dealing ahead of the dissemination of investment research, although Spread Co operates a conflict of interest policy to prevent the risk of material damage to our clients.