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Forex Basics
Forex Basics 1. What is Forex?
The foreign exchange (currency or forex or FX) spot market exists wherever one currency is traded for another. It is the largest financial market in the world, and is made up of Central Banks, International and Commercial Banks, Corporate's, Hedge Funds and other currency speculators. The average daily turnover in the global forex markets is currently around US$ 3.2 trillion. Retail trade is now only a small fraction of this market and speculators have taken over. All currencies are traded in pairs and each is assigned with an abbreviation. Here are some of them:
The rate at which currencies are exchanged one for another is called the currency exchange rate. For example, the "EUR/USD exchange rate is 1.4200" means that one EUR is exchanged for 1.4200 US Dollars. 1.1 The Purpose
Foreign Exchange 'trading' is undertaken for many different reasons. Some is for commercial purposes, payments for imports or converting export receipts. Corporate's will be hedging capital flows and covering exchange risk of their offshore entities. Banks will be covering their commercial flows, corporate deals and trading for profits through their Treasury areas. Traders everywhere will try to generate profits, by speculating on whether a currency will rise or fall in value in comparison to another currency. 1.2 Global market
As of April 2007, the average daily turnover in foreign exchange markets had reached 3.2 trillion USD (BIS Survey figures). This is an increase of 71% from volumes traded in 2004, and is far stronger than the increase between 2001 and 2004. Market participants have put this down to lower levels of volatility and risk aversion, and the significant expansion in the activity of hedge funds coupled with a marked increase of 'technical' trading. 1.3 New Zealand MarketAverage daily turnover on New Zealand's foreign exchange market has ballooned to US$13 billion from US$7.5 billion in 2004 and US$4.2 billion in 2001, according to figures released from the RBNZ. Of these figures 55 per cent of total turnover was in NZ/US dollar transactions, 21 per cent was in AUD/USD and 9 per cent was in EUR/USD. The AUD/NZD, USD/JPY, and GBP/USD business each accounted for 3 per cent of turnover. The large increase in 'spot' volumes was partly attributable to relatively high interest rates and the attraction of the NZD as a 'carry' trade.
2. How an FX trade Works
The objective of currency trading is to exchange one currency for another in the expectation that the market rate or price will change so that the currency you bought increases in value relative to the one you sold. Any foreign exchange transaction ultimately begins with two events:
• One currency has been purchased • The other currency (of that pair) has been sold. The currency that has been sold will needed to be funded on a day to day basis, and the currency purchased will earn interest. After gaining an intuitive understanding of how exchange rates move, one can begin FX trading, thereby speculating on the exchange rate so as to potentially reap profits from the fluctuating value of currencies. 2.1 Going Long or Short
A long position is when a trader buys a currency at one price with an aim to sell it later at a higher price. In this scenario the trader will benefit from a rising market (price goes up) and must sell the currency back in order to lock in the profit. This is also referred to as the notion of "buy low, sell high" in other trading markets.
For example: A trader believes that EUR/USD is moving higher and buys 10,000 EUR at 1.4200 (sells 14.200 USD). Assuming they are right and EUR/USD goes up to 1.4250/1.4253 they then decide to close the position: when you close a long position you sell the base currency (10,000 EUR in our example) and buy the quote currency (10,000*1.4250 = 14250 USD):
A short positionis one in which the trader sells a currency in anticipation that it will depreciate, and they can buy it back later at a lower price. Under this scenario the trader is looking for a 'falling market' and must buy the currency back in order to lock in the profit. This is the opposite of a long position.
For example: A trader believes that GBP/USD is moving down and sells 10,000 GBP at 2.0400 (buys 20,400 USD). Assuming they are right and GBP/USD goes down to 2.0300/2.0305 and you decide to close the position: when you close a long position you buy the base currency (10,000 GBP in our example) and sell the quote currency (10,000*2.0305 = 20305 USD):
On our trading platform, you will notice that there are two prices for each currency pair. Similar to all financial products, FX quotes include a "bid' and "offer" (also known as 'ask'). A bid price is the price that a buyer (LatitudeFX) is willing to pay to purchase a particular currency pair and where the counterparty (clients) can sell that currency pair at a particular time. An offer or ask price is the rate at which the seller (LatitudeFX) is willing to sell a particular currency pair and where the counterparty (clients) can buy that currency pair at a particular time. The bid/ask combination makes up a quotation, which is based on a floating exchange rate. For example, in the EUR/USD pair, the quote might be 1.4150/55.
3. Calculating Profit and Loss in Leveraged Trading
3.1 Pip
Sometimes also referred to as a 'tick' the term is used in currency markets to represent the smallest incremental move an exchange rate can make. Because the majority of exchange rates are quoted to the fourth decimal place, (ie EUR 1.3744 NZD 0.7885) then a one 'pip' move would be 0.0001 to 1.3745 and 0.7886 respectively. The value of a 'pip' is not always the same and can differ per currency. Here are some examples based on a currency amount of 100,000 units of the BASE currency;
• EUR/USD = 10.00 USD
3.2 Leverage
The most enticing aspect of trading Forex in the last 5 years is the high degree of leverage used. Leverage is the degree to which a client or investor can use borrowed money. To enable them to do this they place an amount of money on deposit with a firm (margin) and effectively borrow against this money. Leverage of 50/1 or 100/1 is common. However, it comes with greater risk. If an investor uses leverage to make a currency trade and the position moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged - leverage magnifies both gains and losses.
Leverage seems very attractive to those who are expecting to turn small amounts of money into large amounts in a short period of time. However, leverage can be a double-edged sword. It can magnify the losses as well as the gains. Most traders analyze the charts correctly and place sensible trades, yet they tend to over leverage themselves (get in with a position that is too big for their portfolio). As a consequence they often end up forced to exit a position at the wrong time because they cannot meet a margin call or their positions have been closed out for them. However, properly managed, leverage is a powerful tool and has been used successfully in equity markets over many years.
3.3 Margin Explanations
Margin Account Is an account in which a company or brokerage firm involved lends the client (trader) cash with which to trade financial products. Unlike a normal cash account a margin account allows the client to trade these products with money that effectively he/she does not have. Initial Margin The initial or original amount required by the firm to be placed on deposit before the client can begin 'trading'. This is normally a set standard amount.ie $10,000 of the base currency they wish to trade in.
Variation Margin Is the additional margin required to bring the clients account up to the required level due to fluctuations within the market. Also known as a 'top-up' Margin Call A call from the company to a client (trader) demanding the depositing of further monies to satisfy an in-house requirement and provide cover for an adverse price movement With a trading platform clients are advised in advance that their initial margin is becoming too low to cover their existing positions and warned that a 'top-up' is required. Close Out Is the liquidating of a traders position or positions because that account holder failed to meet a variation margin or margin call. Please note As per the client agreement the client will automatically be closed out if their positions fall below the 2% threshold. 3.4 Profiting from trades You buy a currency if you expect the first-named currency to strengthen against the second second-named currency, and you sell a currency if you expect the first-named weaken against the second-name currency. Example of making money by buying NZD's:
Example of making money by selling NZD's:
4. Other Key Concepts in Currency trading
4.1 Interest Rollovers (overnight funding)
For positions still open at "cut-off time" (usually 5pm New York EST), there is a daily rollover interest rate that the trader either pays or earns, depending on your established margin and position in the market. If you do not want to earn or pay interest on your positions, simply make sure they are all closed before 5pm EST, the established end of the market day. Since every currency trade involves buying one currency and selling another then interest rollover charges are part of forex trading. Interest is paid on the currency that is sold (borrowed), and earned on the one that is bought. If a client is buying a currency with a higher interest rate than the one he/she has sold (borrowed), the net differential will be positive (i.e. USD/JPY) - and the client will earn interest as a result. Ask your client sales representative about specific details regarding rollover if you are unsure. Rollover example:
You are long 100,000 EUR/USD. The EUR/USD at rollover is trading at 1.1800, EUR short-term interest rate is 2.25% and the USD short-term interest rate is 4.00%, the theoretical rollover calculation would be as follows: contract notional value x (base currency interest rate - quote currency interest rate) / 365 days per year x current base currency rate = daily rollover interest debit/credit Therefore: 100,000 x (2.25% - 4.00%) / 365 x 1.1800 = daily rollover interest debit/credit Further: 100,000 x -1.75% / 365 x 1.1800 = USD -$5.66 rollover debit to your account Since you are long a base currency (EUR) bearing a lower interest rate than the quote currency (USD), you will pay for that rollover.
Likewise if you are long 100,000 NZD/JPY. The NZD/JPY at rollover is 89.50, NZD short term interest rate is 7.50% and the JPY short term interest rate is 1.25%, the theoretical rollover calculation would be as follows: Therefore: 100,000 x (7.50% - 1.25%) / 365 x 89.50 = daily rollover interest debit/credit Further: 100,000 x 6.25% / 365 x 89.50 = 1532 JPY or NZD17.12 rollover credited to your account. Since you are long a base currency (NZD) bearing a higher interest rate than the quote currency (JPY), you will earn interest for that rollover.
5. Type of order
5.1 Market order
A market order is an order to buy or sell a currency pair at the current market price.The advantage of a market order is you are almost always guaranteed your order will be executed (as long as there are willing buyers and sellers). Since every currency trade involves buying one currency and selling another then interest rollover charges are part of forex trading. Interest is paid on the currency that is sold (borrowed), and earned on the one that is bought. If a client is buying a currency with a higher interest rate than the one he/she has sold (borrowed), the net differential will be positive (i.e. USD/JPY) - and the client will earn interest as a result. Ask your client sales representative about specific details regarding rollover if you are unsure. 5.2 Limit Order (or take profit order)
A limit order is an order tied to a specific position for the purpose of locking in the gains from that position. A limit order placed on a buy position is an order to sell. A limit order placed on a sell position is an order to buy. A limit order remains in effect until the position is liquidated or cancelled by the client. For example, if a trader has an open position where he is long (meaning he has bought) EUR/USD at 1.4233. In such a scenario, a trader can place a limit order to determine at what rate he will close his position and take his profits. So, for instance, if the aforementioned trader was looking to capture 100 pips on the EUR/USD, he would place a limit order at 1.4333; if the market reached that rate, he would be taken out of the market, and his profit from the trade would immediately be reflected in his balance. A stop order (also stop loss order) is an order linked to a specific position to close that position and prevent additional losses. A stop-loss order placed on a long position will be an order to sell if the market continues to move lower. A stop-loss order placed on a short position will be an order to buy if the market continues to move higher. A stop-loss order remains in effect until the position is liquidated or cancelled by the client. Stop-loss orders are one of the most highly recommended tools for traders. They are crucial to ensuring that the trader does not lose all the money with a single trade, and can be vital when establishing risk-reward ratios to ensure that traders are not making foolish decisions. For example, if a trader is long EUR/USD at 1.4200, he may wish to minimize the loss he is willing to accept by placing a stop loss order at 1.4170, in this case, if the market reached 1.4170, he would be "œstopped" out of the position and would have suffered a loss of about 30 pips. 5.4 Entry order
An Entry Order is an order to enter the market at a specified price. Entry orders are divided into two types, Limit Entry and Stop Entry orders. a) Entry Limit Order: An order initiating an open position to sell as the market rises, or buys as the market falls. The client believes the market will reverse direction at the level of the order. Limit entry orders are often conducive to strategies pertaining to range-bound markets, where clients can place orders to buy at the bottom of the range and sell at the top. b).Entry Stop Order: An order initiating an open position to sell as the market falls, or buys as the market rises. The client placing the order believes that prices will continue to move in the same direction as the previous momentum after hitting the order level. 5.5 Good till Cancel (GTC)
A Good Till Cancelled (GTC) order is an order to buy or sell at a specified price. This order remains open until filled or until the client cancels. 5.6 One cancels Other (OCO)
A stop-loss order and a limit order linked to a specific position. One order, the stop, is to prevent additional loss on the position, and one order, the limit is to take profit on the position. When either order is executed, closing the position, the other order is automatically cancelled. For example, a trader buys EUR/USD at 1.4200, looking for a long term move to 1.4250, however, they decide that if the EUR/USD moves below 1.4170, they will close out their position. So they put a limit order at 1.4250, and stop order at 1.4170, when one order has been filled, the second order is automatically cancelled.
Fundamental Factors
Fundamental Factors Affecting Foreign Exchange Markets Introduction
There are two basic forms of analysis used in currency markets:
technical and fundamental. Fundamental analysis looks at the economic
conditions that affect the value of a currency, trying to predict both
where the currency may be headed and whether it is currently fairly
priced. Given that exchange rates are priced as the value of one
currency against another, so too economic analysis is relative.
Macroeconomic Indicators At its simplest, fundamental analysis attempts to measure and judge the health and outlook for an economy. Stronger growth should underpin a strong currency, while weaker growth would indicate a weaker currency. It is important to watch for shifts in the trend, but in the context of what a currency already is reflecting and how this compares with other economies (relative growth).Official economic releases are reliable and regular indicators of the state of play in an economy and many private sector releases are also useful to follow. All major economies release data on the key parts of the economy, coming together with the release of the National Accounts (or GDP). Major releases watched by currency markets include: • GDP • Industrial production / durable goods order / Institute of Purchasing managers (both manufacturing and non-manufacturing) • Retail sales / private income and spending / consumer confidence • Employment , unemployment and wages • Trade data, imports and exports and the current account • Home sales, house prices, housing finance, construction spending • Survey data such as business and consumer confidence, and data such as the US Federal Reserve's Beige Book (which assesses various anecdotal indicators of economic activity) • Inflation indicators - such as Consumer Price Index, Producer Price Index, import and export prices, and inflation expectations
Economic calendars are a critical guide to approaching data that could impact currency markets.
The influence of any particular indicator will depend on what issues
investors are currently focused on, and this changes frequently. For
example, if inflation is the concern then inflation indicators will be
key, whereas if the market is worried about the state of housing -as is
currently the case in the US - then the focus will be on housing data.
In addition to assessing the trends in these indicators, investors
must also look at how each piece of data relates to expectations.
Remember, expectations are a critical part of financial market trading.
Thus a currency could strengthen even if a piece of data that shows a
weakening trend but still beat expectations (and vice versa). In a
similar vein, rumours can also impact currency markets.
Interest rate differentials In addition to growth, currencies are also highly correlated with interest rates and particularly relative interest rates (or interest rate differentials). Indeed, in recent years, this has become a key determinant of trends in currency markets. Interest rates are the 'price' of money, and high interest rates encourage global capital to flow in to an economy, boosting the value of its currency. Currency markets look at both short term 'cash' rates as well as longer term bond yields. Rising interest rates - especially relative to interest rates elsewhere - indicate a stronger currency and vice versa. The most recent example of this is the strong appreciation of NZD/JPY in recent times, with Japan interest rates close to zero but NZ cash paying over 8%. In major economies, the central bank sets the cash rate, which anchors the longer end of the yield curve. Central banks use the cash rate as the key policy tool to manage the economy, aiming to contain inflation and extend the business cycle. In most cases, central banks target 'low and stable' inflation, with many running explicit targets for inflation. Simply, when inflation is rising, monetary policy is tightened by raising the cash rate, and vice versa. As a result CPI data is critical. However, policymaking is rarely this simple, as the central bank
attempts to pre-emptively move against future inflation pressures. As
such policymakers look at a whole range of factors - including economic
growth, wages, the degree of resource utilisation, unemployment and
inflation expectations - and, given this, currency markets carefully
monitor policy speeches by central bank members (such as Fed Governor
Bernanke).
Current account balances Current account balances also influence currency valuations. A country running a current account deficit is importing more than it is exporting and / or borrowing more than it is saving. Economic theory argues that this imbalance can be addressed by a weaker currency, which would make exports cheaper and imports more expensive. The opposite is the case for an economy running a current account surplus. While correct in theory, this tends to be a longer term indicator of currency trends. Indeed, the US economy ran a significant current account deficit through the 1990s while the USD appreciated relentlessly courtesy of the productivity boom. Nonetheless, at times, financial markets still worry about these issues. Other fundamental issues There are many factors that can influence the overall health and outlook for any given economy and indeed the global economy. Currency markets, more than any other financial market, trade on the back of news from many sources. Other issues that can impact:
• Politics - both within a country and in the international domain • Central bank intervention (individual or collective) - recently, central bank intervention has been focussed on ensuring smooth functioning of the market, rather than defending a level. • Risk appetite - when investors are seeking to extend 'risk', the response to changing fundamentals can be greater than usual • Positioning - if investors have already positioned for improving fundamentals (eg are holding a long position) then the currency may not strengthen further on a robust economic report, and equally could fall more than expected on disappointing news. The opposite is true for a market positioned on the short side. • Natural disasters - for example, a hurricane in the Mexican Gulf can impact the price of oil, which is negative for economies that rely on imported oil • Commodity cycles / Global growth • Purchasing Power Parity - an economic theory that the price of goods in one country should equal the price of those goods in another country, exchanged at the current fx rate (the law of One Price)
In conclusion Fundamental analysis is looking at any factor that shifts the prospects of an economy, and thus its currency. There is a complex web of many factors that can impact, from economic indicators to policy speeches, and many are inter-related. Economic calendars and commentary are critical in assessing and monitoring fundamentals, and investors must bear in mind trend, expectations and relativities.
Technical Analysis
Technical Analysis
1. What is Technical Analysis? Technical analysis is the study of market action by using charts. The technical analyst relies on historic price movement to forecast future price targets. The technical analyst believes that the current market price reflects all market information and considers only the actual price behaviour of the market or instrument. Technical analysis is widely used amongst traders and financial professionals, and some studies suggest that its use is more widespread than is "fundamental analysis' in the foreign exchange market.
1.1 DOW Theory The Dow Theory was developed around 1900 by Charles Dow and provides a basis for technical analysis. The purpose of this theory is to determine the trend of the market which can be discovered using six basic tenets.
1.1.1 The Averages Discount Everything Dow believed that the current market price reflects all the market factors such as information, traders' behaviours etc.
1.1.2 Market has three trends • Uptrend: every following top is higher than the previous one and has a higher troughs (lows) • Downtrend: every following top is lower than the previous one and has a low troughs (lows) • Sideways Channel: peaks and troughs don't successively rise or fall. FX markets are notorious for this type of trend.
1.1.3 Trends have three phases Dow Theory asserts that major market trends are composed of three phases: • An accumulation phase: this is the first phase where all the unfavourable or favourable information has been discounted and the 'smart' money starts to flow into the market, buying or selling the stock against the general opinion of the market. • The Second phase: when the trend changes and other trend followers participate where the Prices increase or decrease rapidly and bullish or bearish markets are evidenced. • The final phase: the markets become irrational and the smart money begins to unwind their position(s) into the market.
1.1.4 Indices must confirm each other Dow's first stock averages were an index of industrial (manufacturing) companies and rail-road companies. When the Dow Theory was being developed, the railroads were a vital link in the U.S. economy. Raw materials were shipped to manufacturers via railroad, so he argued that an increase in activity among the rail stocks would forecast an increase in business activity for the industrial stocks, and the Rail average would usually appreciate before the industrial average. Hence, if the manufacturers' index is bullish but the rail index still remains bearish, then the manufactures index may not be healthy enough. So Dow identified that to confirm the major trend of the market, the manufacturers' index and rail index must move in same direction.
1.1.5 Trends are confirmed by volume Dow believed that volume confirmed price trends. When a price breaks through the resistance level or reaches a new high, it must be accompanied with high volume to confirm the trend.
1.1.6 The Primary trends exists until definitive signals prove that they have ended Dow believed that trends existed until new signals developed. If the last major signal under the theory is bullish, the primary bull market trend remains in force until a bear market signal is given.
1.2 Chart type
Charts represent all the historic data and allow the technical analyst to draw trading signals to forecast the future trend of the market. There are lots of chart types used for this analysis. The primary chart types are:
1.2.1 Line chart Line charts are the simplest type of charts; they are uncluttered and typically populated using the market closing prices.
1.2.2 Bar Chart The bar chart displays a currencies open, high, low, and closing prices. Bar charts are the most popular type of chart used in mainstream analysis. • High - The top point of the vertical bar • Low - The bottom point of the vertical bar • Opening Price - A small horizontal line to the left of the vertical bar • Closing Price - A small horizontal line to the right of the vertical bar
1.2.3 Candlestick chart The candlestick chart also has four primary price points: the high, the low, the open and the close. The body of the candlestick bar is comprised of the difference between the open and close price. If a currency gained value, it meant that the opening price was lower than the closing price. To contrast, if a currency lost value, then the closing price was lower than the opening price.
2. Trend analysis
2.1 Trend line A trend represents a consistent change in prices and illustrates the direction of the market movement. Trends may also be classified by their timeframes as long-term, medium-term and short-term trends. There are three categories of the direction of trend: upward, downward, and sideway. An Up-trend means that every 'next bottom' is higher than the previous one, and every 'next high' is higher than the previous one. A Down-trend means that every 'next bottom' is lower than the previous bottom and every next high is under the previous high. A Sideways trend means that every 'next bottom' or high is at the same level as that of the previous bottom or high.
2.2 Resistance and Support Level
Resistance A pre-determined price level at which selling is expected to take place and buyers will find difficult to go beyond
Support Levels A pre-determined price level at which buying is expected to take place and the sellers will find it difficult to get through. Opposite of resistance. Prices often automatically correct from resistance and support levels.
2.3 Continuation Chart pattern A Continuation Chart Pattern means that after the prevailing price trend has been corrected, the prices will continue in the same direction. We will look at the following patterns that imply trend reversals: Triangles, Flags, Pennants, and Wedges.
2.3.1 Triangles Triangle patterns are continuation patterns and formed when top and bottom trend lines move gradually closer together to form a triangle. When the price finally breaks out of the trend line, it often forecasts a subsequent sharp movement. There are three types of Triangles patterns: symmetrical triangles, ascending triangles, and descending triangles. • A symmetrical triangle is where the upper trend line and lower line both gradually converge together as they extend, effectively mirroring each other • The ascending triangle is a bullish continuation pattern and is formed when the upper trend line is horizontal whereas the lower one is moving upward. • The descending triangle is opposite of the ascending triangle and is a bearish continuation pattern. It usually forms during a downtrend and is recognised by the upper trend line moving downward and the lower one is moving horizontally.
2.3.2 Flag A 'Flag' is a small rectangle pattern which usually exists after a sharp increase or decrease in price. It is formed by parallel lines of 'support' and 'resistance'. The breakout is normally back into the prevailing trend.
2.3.3 Pennant A Pennant is a small symmetrical triangle and also occurs after a rapid movement. It usually exists in the middle of the trend.
2.4 Reversal Chart patterns A reversal pattern signifies that the price is breaking out of the trend and the market could anticipate that the current trend should be exhausted. There are a few recognizable reversal patterns such as 'Head & Shoulders', 'Double Top and Double Bottom', 'Triple Top' and 'Triple Bottom'.
2.4.1 'Head and Shoulders' The most recognizable reversal pattern and always appears at the end of a bullish trend. This pattern is formed by three peaks: the head and two shoulders, where the head is slightly higher than two shoulders and the shoulders are set at close to the same level. A line drawn between the bottoms of the two shoulders is called the neckline. This reversal pattern is completed after the neckline is broken, accompanied by large trading volume.
2.4.2 Double Top: Another frequently used reversal pattern this pattern is formed by two peaks, both tops are approximately equal in height. After initially testing the resistance level the price returns to the support level only to bounce back again to the resistance line. If it fails again, then the price will again return to the support (or neckline). The neckline is a strong support for prices but can eventually fail. This pattern is completed after the neckline is broken, accompanied by large trading volume. Double Bottom pattern is a mirror image of a double top pattern: The average height of the bottoms gives a good indication of the price objective.
2.4.3 Triple Top A Triple top is a cross between a head and shoulders and double top. This pattern is formed by three tops which are approximately equal in height. The line drawn between the bottoms is called the neckline. The neckline is a strong support for prices but can eventually fail. This reversal pattern is completed after the neckline is broken, accompanied by large trading volume. A triple bottom pattern is a cross between an inverted head and shoulders and double bottom pattern and is opposite of the above.
2.5 Basic indicators
2.5.1 MA The Moving average is the mean of previous data points. Normally the market uses the closing prices to calculate the moving average. For example, a 10-day simple moving average of closing prices is the mean of the previous 10 days' closing prices.
2.5.2 RSI The Relative Strength Index (RSI) is a technical analysis momentum oscillator which shows price strength by comparing upward and downward close-to-close movements. The RSI is popular because it is relatively easy to interpret. The formula is The RSI is a price-following oscillator that ranges between 0 and 100. A popular method of analyzing the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing to exceed its previous high. This divergence is an indication of an impending reversal. The way to use it; • Overbought/Oversold: the technical analyst might suggest that when the RSI reaches 70%, it is overbought and when it reaches 30%, it is oversold. However readings over 80% and under 20% are not uncommon. Normally, when the RSI reaches the overbought area, the trader will close their long position and anticipate the price will pull back and when RSI reaches the oversold area, the trader will close their short position and anticipate the price will bounce. • Divergence: A Bearish Divergence occurs when the currency pair is making new highs, but the RSI is failing to surpass its previous high. A Bullish Divergence occurs when the currency is making new lows, but RSI fails to surpass its previous low. Please note- Take profits on divergences. Unless confirmed by a trend indicator, Relative Strength Index divergences are not strong enough signals to trade in a strong trending market. • Chart Formations: The RSI often forms chart patterns such as head and shoulders that may or may not be visible on the price chart. • Failure Swings: when RSI exceed the precious high but after that, it falls below its most recent trough, it is said to have completed a "failure swing." • Support and Resistance: The RSI, like other chart patterns, also has levels of support and resistance.
2.5.3 MACD Moving Average Convergence / Divergence, is a technical analysis indicator to show the difference between a fast and slow exponential moving average (EMA) of closing prices. The formula is MACD is a trend following indicator, and is designed to identify trend changes. Three types of trading signals are generated, • MACD line crossing the signal line • MACD line crossing zero • Divergence between price and MACD levels The signal line crossing is the usual trading rule. This is to buy when the MACD crosses up through the signal line, or sell when it crosses down through the signal line. These crossings may occur too frequently, and other indicators may have to be used.
2.5.4 Bollinger Bands Is similar to Moving Average Envelope indicators in that they both form upper and lower bands around a moving average, this indicator consists of three indicators: A simple moving average in the middle, An upper band (SMA plus 2 standard deviations), A lower band (SMA minus 2 standard deviations).This indicator can give a large amount of information. • Periods of consolidation • Periods when a currency is overextended • Continuation signals • Establishing price targets • Buy and Sell signals
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