indocuments.com

Technical analysis is a method of forecasting price movements by looking at purely market-generated data. Price data from a particular market is most commonly the type of information analyzed by a technician, though most will also keep a close watch on volume and open interest in futures contracts. The bottom line when utilizing any type of analytical method, technical or otherwise, is to stick to the basics, which are methodologies with a proven track record over a long period. After finding a trading system that works for you, the more esoteric fields of study can then be incorporated into your trading toolbox.

Almost every trader uses some form of technical analysis. Even the most reverent follower of market fundamentals is likely to glance at price charts before executing a trade. At their most basic level, these charts help traders determine ideal entry and exit points for a trade. They provide a visual representation of the historical price action of whatever is being studied. As such, traders can look at a chart and know if they are buying at a fair price (based on the price history of a particular market), selling at a cyclical top or perhaps throwing their capital into a choppy, sideways market. These are just a few market conditions that charts identify for a trader. Depending on their level of sophistication, charts can also help much more advanced studies of the markets.

On the surface, it might appear that technicians ignore the fundamentals of the market while surrounding themselves with charts and data tables. However, a technical trader will tell you that all of the fundamentals are already represented in the price. They are not so much concerned that a natural disaster or an awful inflation number caused a recent spike in prices as much as how that price action fits into a pattern or trend. And much more to the point, how that pattern can be used to predict future prices.

Technical analysis assumes that:

• All market fundamentals are depicted in the actual market data. So the actual market fundamentals and various factors, such as the differing opinions, hopes, fears, and moods of market participants, need not be studied.
• History repeats itself and therefore markets move in fairly predictable, or at least quantifiable, patterns. These patterns, generated by price movement, are called signals. The goal in technical analysis is to uncover the signals given off in a current market by examining past market signals.
• Prices move in trends. Technicians typically do not believe that price fluctuations are random and unpredictable. Prices can move in one of three directions, up, down or sideways. Once a trend in any of these directions is established, it usually will continue for some period.

The building blocks of any technical analysis system include price charts, volume charts, and a host of other mathematical representations of market patterns and behaviors. Most often called studies, these mathematical manipulations of various types of market data are used to determine the strength and sustainability of a particular trend. So, rather than simply relying on price charts to forecast future market values, technicians will also use a variety of other technical tools before entering a trade.

As in all other aspects of trading, be very disciplined when using technical analysis. Too often, a trader will fail to sell or buy into a market even after it has reached a price that his or her technical studies identified as an entry or exit point. This is because it is hard to screen out the fundamental realities that led to the price movement in the first place.

As an example, let’s assume you are long USD vs. euro and have established your stop/loss 30 pips away from your entry point. However, if some unforeseen factor is responsible for pushing the USD through your stop/loss level you might be inclined to hold this position just a bit longer in the hopes that it turns back into a winner. It is very hard to make the decision to cut your losses and even harder to resist the temptation to book profits too early on a winning trade. This is called leaving money on the table. A common mistake is to ride a loser too long in the hopes it comes back and to cut a winner way too early. If you use technical analysis to establish entry and exit levels, be very disciplined in following through on your original trading plan.

Price charts

Chart patterns
There are a variety of charts that show price action. The most common are bar charts. Each bar will represent one period of time and that period can be anything from one minute to one month to several years. These charts will show distinct price patterns that develop over time.

Candlestick patterns
Like bar charts patterns, candlestick patterns can be used to forecast the market. Because of their colored bodies, candlesticks provide greater visual detail in their chart patterns than bar charts.

Point & figure patterns
Point and figure patterns are essentially the same patterns found in bar charts but Xs and Os are used to market changes in price direction. In addition, point and figure charts make no use of time scales to indicate the particular day associated with certain price action.

Technical Indicators

Here are a few of the more common types of indicators used in technical analysis:

Trend indicators
Trend is a term used to describe the persistence of price movement in one direction over time. Trends move in three directions: up, down and sideways. Trend indicators smooth variable price data to create a composite of market direction. (Example: Moving Averages, Trend lines)

Strength indicators
Market strength describes the intensity of market opinion with reference to a price by examining the market positions taken by various market participants. Volume or open interest are the basic ingredients of this indicator. Their signals are coincident or leading the market. (Example: Volume)

Volatility indicators
Volatility is a general term used to describe the magnitude, or size, of day-to-day price fluctuations independent of their direction. Generally, changes in volatility tend to lead changes in prices. (Example: Bollinger Bands)

Cycle indicators
A cycle is a term to indicate repeating patterns of market movement, specific to recurrent events, such as seasons, elections, etc. Many markets have a tendency to move in cyclical patterns. Cycle indicators determine the timing of a particular market patterns. (Example: Elliott Wave)

Support/resistance indicators
Support and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trend Lines)

Momentum indicators
Momentum is a general term used to describe the speed at which prices move over a given time period. Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest at the beginning of a trend and lowest at trend turning points. Any divergence of directions in price and momentum is a warning of weakness; if price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price di

Chinese Yuan Accelerates Upwards When Henry Paulson was appointed Secretary of the US Treasury last year, he made China and its purportedly undervalued currency a cornerstone of his economic plan. Lo and behold, several months ago, the Yuan suddenly accelerated in its upward path against the Dollar, rising at an annualized rate of 14%. Currency futures are now pricing in an 8% rise in 2008, while several economists are forecasting a 10% increase. Ironically, there are still American policymakers who think the Yuan is appreciating too slowly, as well as Chinese policymakers who reckon it is increasing too rapidly. Accordingly, the current pace probably represents a fair compromise. Besides, inflation is threatening the US, so a slow appreciation would enable the economy to adjust to higher prices in the long term. While China also faces rising inflation, it doesn’t want to send investors the message that the movement of its currency is uni-dimensional, which would encourage further inflows of speculative capital. The Economist reports: But Chinese policymakers have stressed the need for gradual adjustment. To show that the currency is not just a one-way bet, the PBOC may try to nudge the yuan a bit lower in coming days.

Volatility Drives Yen

As Asian capital markets crash in unison, the Japanese Yen is rising at its fastest pace in years.  Taken out of context, that sounds like a contradiction, since a positive correlation typically obtains between the strength of a nation’s economy, capital markets, and currency.  However, the Yen is unique, as most forex traders are doubtlessly aware.  The Yen rises and falls with the whims of the carry trade, which in turn is tied closely to volatility.  And in case you haven’t noticed, global capital markets are seesawing to such an extent that by some measures, volatility levels have reached a nine-year high.  One analyst has drawn a parallel between the current credit crisis and the 1998 Asian economic crisis, which also produced a Yen rally.

Fed Dramatically Lowers Interest Rates

Last week, the New York Times published an article with the byline “Is the Federal Reserve’s chairman, Ben Bernanke too nice for the job?” Apparently, talk had been building on Wall Street that Bernanke was not tough enough to deal with the growing problems faced by the world’s largest economy.  Bernanke responded publicly in a speech in which he promised that the Fed would act quickly and decisively to confront such problems.  Then on Tuesday, the critics were silenced peremptorily by a Fed rate cut of 75 basis points, the largest single cut in two decades. Moreover, Bernanke intimated that additional rate cuts could come as soon as next week. 

It’s unclear how this activity will affect the Dollar.  On the one hand, it implies beyond a reasonable doubt that the US economy is indeed headed for recession.  Bond yields are declining and the stock market has lost 15% of its value since October.  On the other hand, the Fed has demonstrated that it is willing and able to take the necessary steps to avoid a hard landing at any cost. At the same time, investors around the world fear that a US recession will have an adverse impact on the global economy.  And where do investors park their money during periods of global economic uncertainty? Answer: USA. Sure enough, the Dollar has already begun to rally after taking a big hit immediately following the rate cuts.

Foreign Investors Target US

So-called ‘Sovereign Wealth Funds’ are the talk of the town, stealing headlines as part of a multi-billion dollar buying spree.  Anecdotally, stories of these funds and other institutional foreign investors have made a big splash, epitomized by a few high-profile investments in struggling American investment banks.  It no longer appears these stories were isolated, as suggested by some pretty compelling economic data.  In 2007, total foreign direct investment into the United States totaled $400 Billion, which represents a 90% increase over 2006.  In addition, the first few weeks of 2008 saw a frenzy of activity, which suggest this trend will continue.  Investment in the US is being driven primarily by a weak Dollar and attractive stock market valuations.  If the bad news on the US economy continues to pour in, analysts warn that foreigners could play an even larger role in mitigating against recession. The New York Times reports:

The weak dollar has made American companies and properties cheaper in global terms. Even as Americans confront the prospect of a recession, economic growth remains strong worldwide, endowing oil producers like Saudi Arabia and Russia and export powers like China and Germany with abundant cash.

South African Rand Resumes Trend

The South African Rand is not the subject of much analysis in the forex community, which typically confines itself to the majors and the BRIC currencies - Brazil, Russia, India, and China. But recently, the Rand found itself on the radar screen  of at least one analyst, who pondered the implications of a growing trend towards risk aversion. It appears that the Rand has resumed a clearly identifiable downward path against the Dollar, a course which had been temporarily interrupted in the early years of the decade.  Now, inflation is picking up  again and investors globally are becoming more hostile towards risk, two factors which bode ill for the Rand.  On the other hand, South Africa is rich in natural resources; judging from the performance of the Canadian Loonie and the Australian Dollar, commodity economies are still in vogue. The Times reports:

The curve ball for precious metals would be a sustained stronger dollar, unlikely while the US economy is in its current predicament and the Fed is cutting rates.

BOC Cuts Rates

Last week, the Bank of Canada cut interest rates by 25 basis points, bringing its benchmark lending rate down to 4%.  Fortunately for the Canadian Dollar, the rate cut paled in comparison to the 75 basis point move effected by America’s Federal Reserve Bank. While the Bank of Canada offered a hackneyed rationale of “keeping aggregate supply and demand in balance”  for the change in monetary policy, there is still some surrounding haze since Canadian inflation is rising and economic growth is strong. The currency had slipped below parity against its American counterpart, but is now slowly crawling its way back. If commodity prices remain high, the currency will likely push back across that psychologically important barrier of 1:1 with the USD.