For many investors, the world of foreign exchange trading, also referred to as FOREX, can be somewhat mysterious. This is primarily due to the fact that FOREX lingo, strategies and even the charts used to plot price action do not always match those used in standard stock market trading. Although FOREX markets are teeming with activity and energy, many investors simply choose to ignore them due to what they perceive as a stiff learning curve and high barrier to entry.
Understanding how to read a FOREX chart can actually be accomplished relatively easily. Mastering the basics of candlestick reading, as well as various support and resistance measures, will help ensure that you have the information you need to begin honing your trading skills in the vibrant world of FOREX.
In order to properly analyze price action in FOREX charts, you will need to have a solid grasp of how support and resistance lines function, as well as how to interpret candlestick charting.
Exploring the Basics of FOREX Charts
In the world of FOREX currency, the majority of the charts used to assess price action are built upon a comparison between the specific currency "pair" selected by the trader. This is primarily due to the fact that FOREX trades are commonly executed as part of currency pairs, meaning that a trader will be buying and selling specific currencies in exchange for other currencies.
Since there is no universal standard of measure when it comes to currency, the price action for any single monetary unit will always be grounded in a second currency. For example, if you are charting the value of the U.S. dollar, its value must be interpreted as a value relative to another currency. Common pairs involving the U.S. dollar include USD/EUR (the U.S. dollar compared to the Euro), as well as USD/GBP (the U.S. dollar compared to the British pound).
Although there a variety of popular pairs that are typically used by the majority of traders, there is no reason why a chart cannot be made for any currency pair imaginable. Keep in mind, however, that just because a chart can be made does not imply that a specific currency pair can actually be traded in the real-world markets. Factors such as availability and liquidity may limit the scope of available trades somewhat, although this should not affect the vast majority of FOREX traders.
Understanding FOREX Candlesticks
Once a currency pair has been selected for charting, the next step for FOREX traders is to determine exactly what information is being represented by the candlesticks that appear on the price action charts. Although the candlestick design may be somewhat confusing at first, this particular method of data visualization provides a trove of useful information for FOREX traders.
The candlestick is divided into three primary sections, those being the "open," the "close" and the "wick." Each of these elements works in tandem to provide FOREX traders with a comprehensive understanding of recent price action. The candle itself will also be highlighted in one of two colors: green (or blue) and red.
The color of a candlestick is perhaps the easiest element of the price chart to interpret. If the candlestick is green or blue, this communicates to the investor that the closing price for a currency is above the opening price. Inversely, the stick will turn red if the closing price for a currency is below the opening price. Even without additional information provided by the candlesticks, this simple analysis of price activity will allow investors to gain a more accurate and informed understanding of how the particular value of a currency is changing over time.
Digging Deeper Into FOREX Candlesticks
When you begin to examine a candlestick chart, your first question may be, "How do I know what length of time each candlestick represents?" Without this information, the chart itself would become almost completely irrelevant. As a general rule, each candlestick represents an identical amount of time, the specific duration itself being flexible. A trader can access charts where each candlestick represents one hour of time, and can also explore more long-term charting where each candlestick represents a single day.
So, combining the information already discussed about duration and color, consider the following example: a green candlestick appears on a chart chronicling price action over a one-week period. There are seven total candlesticks, each representing a 24 hour period. With this information, an investor should be able to infer that the closing price of the currency was above the opening price over a 24 hour period represented by the candlestick in question.
Evaluating the Candlestick Wick
Although the body of the candlestick provides ample information related to price action, further information directly related to FX pricing is made available through the use of wicks on the candlestick in question. When a wick appears at the top of the candlestick, it is commonly referred to as the "upper wick" or "upper shadow." Similarly, when a wick appears at the base of the candlestick, it is referred to as the "lower wick" or "lower shadow." Regardless of where it appears on the candlestick, the primary function of the wick is to provide chart readers with a clear understanding of the full range of price motion that occurred that day.
The tip of the wick, also known as the shadow, will dictate the highest and lowest price point reached during the duration of the candlestick. The greater the distance from the opening and closing value of the currency, the more extended the wick will appear.
For some industry analysts, the length of the wick for a candlestick could be an indication as to whether or not a correction is in order for the currency. This correction could either result in a decrease in the value of the currency or an increase. The prediction will depend entirely on whether or not the wick appears on the upper or lower end of the candlestick. For example, some analysts consider a lower wick to be an indication that a rise in currency price will occur relatively soon.
Of course, a variety of parameters could influence such price action, meaning that there is no truly direct relationship between the direction and size of the wick and price action. Basing trading action exclusively on a parameter such as this could elevate risk, particularly for new traders who have yet to gain valuable experience within this marketplace.
Identifying Candlestick Patterns
Not only do individual candlesticks provide a variety of insights related to price action in FOREX markets, but the specific grouping of candlesticks may fall into one of several "patterns" identified by traders as an indication of future price movement.
The "three line strike" pattern, for example, consists of three red candles occurring in succession. Each of these candles creates a new low price point and will likely close somewhere near an intrabar low price point. Following the third red bar, however, is often a green/blue bar which may open at a lower price point than the close of the previous candlestick. This candlestick will often reverse the previous three candlestick trend and provide a noticeable price correction that is favorable to investors.
Yet another common candlestick pattern is referred to as the "two black gapping." Here, a succession of two red candlesticks separated by a significant downward gap will likely occur following a relatively stable long-term upward trend. Following the "two black gapping" pattern, the door has been opened for further downward price momentum, although this is not guaranteed. Instead, investors are advised to approach this particular scenario with a degree of caution and observation, ensuring that they stay abreast of these dynamic situations.
The "evening star" is another unique candlestick pattern which is typically initiated by a tall green/blue candlestick that carries price levels well above the current highs. Following this candlestick, however, investors should typically expect a short red candlestick as the number of interested buyers begins to thin, following by a large red candlestick signaling the end of upward pricing momentum and the initiation of a correction.
Introducing Resistance Lines
Using the candlesticks and the various patterns described previously, technical analysts begin to introduce what are commonly referred to as support and resistance lines on their charts. Although there is no absolutely precise method for identifying support and resistance levels, analysts identify them based upon previous price action. For example, if recent candlesticks reached new price highs before retreating, the highest recorded price level prior to the correction would be considered a resistance level.
Similarly, if price levels retreated to session lows before bouncing back, the lowest price point reached prior to the upward correction would be considered the support level. Essentially, both support and resistance levels can be defined as a specific point at which investor enthusiasm to buy or sell a currency has diminished to the point that the trade is not executed.
Given the volatile nature of FOREX trading, support and resistance lines can help traders predict with some degree of certainty what may be in store for them in the near future. For example, if a currency is unable to breach a support line, investors may feel secure in choosing to maintain their positions rather than selling and cutting losses. However, in the event that a support line is broken, this is often a strong signal to carefully evaluate current positions and determine an acceptable degree of risk, as the possibility of further downward price momentum has increased significantly.
Practicing FOREX Price Action Charting
No matter how long you have been involved in FOREX trading, a thorough study of modern charting methods is absolutely indispensable. Although risk will always be involved in the FOREX marketplace, or any trading environment for that matter, a comprehensive understanding of candlesticks, support lines and a variety of other analytical tools used today will ensure that you have the best possible resources at your disposal.
If you are first starting out in the world of FOREX trading, you may consider exploring and testing various analytical strategies using one of several FOREX simulators available on the market today. These platforms will allow you to invest simulated funds and try out a variety of tactics before you begin to deposit your own funds for actual trading.
As with any form of investing, practice and patience will build the foundation of future success. Try to resolve any questions you have concerning charts and price action through the help of a financial expert or online resource as soon as possible to ensure that you are making the best trades possible.
- Use other technical indicators such as stochastic and the Moving Average Convergence-Divergence to help you analyze the price action.
- Do not trade if the market is choppy. No one ever lost money waiting on the sidelines for a good trading opportunity to emerge.
Ryan Cockerham is a nationally recognized author specializing in all things business and finance. His work has served the business, nonprofit and political community. Ryan's work has been featured on PocketSense, Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.