Go from Newbie to Intermediate on Forex Charts in One Article- The Guide
If you are reading this, we welcome your interest to learn one of the outstanding sectors of the trading industry. Some have attempted and given in along the way. While Forex chart reading may seem complicated, it is straightforward once you get the hang of it.
In this article, we discuss in simple language, how you can interpret any chart feature in your trading platform. From chart timeframes to line, bar and candlestick Forex charts, we explain everything you will need to know to navigate the interesting world of international currency trading.
Forex traders use different techniques to envisage the movement of currency pairs. While some employ technical strategies, others use fundamental techniques. Still, a good number of traders prefer quantitative means.
During trading, you will rely on news to inform your decisions. Studying interest rates and economic variables are also effective ways to make a winning on a trade. Whatever trading method you choose is up to you. But the common thing is that all traders must learn to read the charts. It is a given.
Fortunately, the experts at Forexadvice.co.uk have put together this comprehensive guide to leapfrog you from beginner to intermediate trader. After all, before fly, you must first learn to walk.
A refresher on the basics
We always like to assume that every beginner is hearing ‘Forex’ for the first time, so we start with the basics. Even if you already know the definition, brief refresher won’t hurt.
Forex is simply an acronym for “Foreign Exchange”. It is the act of buying and selling international currencies in the foreign exchange market. In the world foreign exchange market, individuals, investors, retailers and institutions speculate on the relative value of one currency conversion to another through buying and selling of currency pairs.
The Forex market is a vibrant, liquid marketplace with a daily net worth of about 5.3 trillion dollars.
How to interpret a Currency Quote
Forex is about currency conversion. The market is always quoted in pairs because you are comparing the value of a currency to another.
For example, the quote GBP/USD suggests how many dollars you can get for the value of £1.
The first currency (GBP) is known as the base, while the second is the quote. When you purchase a currency pair, you purchase the base currency and sell the quote currency. So far so good?
Understanding what a Pip means
You will often hear Forex traders mention “Pip”. This is the unit of measuring a profit or loss. A standard Forex pair is quoted to 4 decimal places, such as 0.0001. The pip is the ‘1’ located four places after the decimal point.
If a trader buys EUR/USD for 1.7000 and decides to sell it at 1.7030, the difference is 0.0030 or 30 pips. He can say he made a profit of 30 pips.
However, when it comes to Yen pairs, there is an exception. For example, GBP/JPY, is only quoted to two decimal places. Here, the second place after the decimal point is the pip.
Hopefully, this crash course has brought you up to speed. We can the proceed to reading a Forex chart.
What is a Forex chart ?
In simple terms, a Forex chart is the graphical representation of the rate of exchange between two currencies. It gives traders an idea of how the exchange rate between a currency pair has fluctuated over time.
For example, when studying a GBP VS USD chart, you can determine how minimally or severely the exchange rate between the British pounds and the US dollar has changed in a given period.
The graph above shows how volatile the GBP became against the USD following the announcement of Brexit last year. The market went in a brief panic of uncertainty, resulting in the drop of the British pounds. The result led to an all-time low in 30 years for the Sterling. The markets have since cooled off but you can learn more about the results in this article.
Forex charts can be plotted for different currency pairs; from the main pairs such as GBP/USD and EUR/USD to minor pairs like NZD/JPY and AUD/CAD.
Traders can choose any currency pair they want.
Forex Chart timeframes and how they work
The time displayed on the chart depends on the specific timeframe you choose. Forex charts, by design, are always set to 1D (that is daily) timeframes.
This means that each position on the graph represents trading data for one day, whether it is a line, bar or candle.
If you decide to change the timeframe to 120-minute chart, each position on that chart would now signify the trading data in the last 120 minutes.
Many free Forex charting programs allow you to choose the timeframe you want to display. It could be as short as a minute to as long as 4 weeks! With more sophisticated charting software, you can view even shorter timeframes.
Types of Forex Charts
Over the course of trading, the industry has developed many types of Forex charts to display trading data.
There are three major types of Forex Charts namely:
- Line charts
- Bar charts
- Candlesticks charts
For obvious reasons, the candlesticks charts are currently a favourite amongst most Forex traders. In comparison to a line chart, which depicts the price about to close, candlestick charts reveal four times the quantity of information including the open, close, high and low prices of a given period.
With this additional information, you can study the movement of price over a specific period, as opposed to just seeing it after it has closed. The red and green parts of a candle (pictured above) is called ‘the body’.
The body of a candlestick shows the difference between the opening and closing currency price over a chose time frame.
If the candle’s opening price is lower than the closing price, the body will be green, but if the opening price is higher than the closing price, the candle’s body will be red.
The visible black lines above and below the candles are known as ‘shadows’ or ‘wicks’. Shadows are the highest and lowest prices achieved during a specific period.
Forex Indicators: A summary
Market behaviour is evaluated by traders by using currency charts. It also helps them speculate the position of the currency in future. To have a better idea of currency movements shown on a chart, traders have designed various visual guides to help them. They are called indicators.
There are several hundred trading indicators, each one representing various aspects of Forex trading, from trend watching to mean reversion. Mean reverting is an indicator process where market prices are believed to revert to its original position if it strays to far from the core line.
Below are a few common market indicators.
The eponymous indicator was developed by John Bollinger. Bollinger Bands are volatility bands place multiplied by standard deviations around a dynamic average. In times of increasing volatility, the bands widen, and when volatility decreases, the bands narrow.
The chart above shows Bollinger bands for technical analysis.
The charts are traditionally used to indicate likely oversold and over-purchased regions. For instance, if price position exceeds that upper band, it may be expected to revert to its mean position. In some cases, it will revert to its middle dynamic average.
Relative strength index (RSI)
This Relative strength index was designed by J. Welles Wilder. It is a momentum oscillator with evaluates the velocity and direction of price movements. The indicator works by comparing the upward and downward movements of the closing price at specific periods. Wilder chose 14 periods as the default period.
The RSI formula is 100 – 100 / (1 + RS)
RS is the Average Gain divided by Average Loss
Average Gain = [(total gain over past 14 periods/ 14) x 13 + present gain] /14
Average Loss = [(total loss over past 14 periods/ 14) x 13 + present loss] /14
Simple Moving Average Line
The Simple Moving Average or SMA is arguably the most popular indicator drawn on Forex charts. Moving averages help traders smoothen fluctuation of prices over a given period, thus presenting them with a better idea of the potential price direction.
The formula is Total closing prices/ number of periods
Step 2: Choosing a chart and reading it effectively
Now we have addressed certain key terminologies, chart types and indicators, it is also important to take a practical approach. This next step explains in detailed but simple language, how to select the right charts, interpret them correctly and take effective action based on your results.
There are many good charting software available for free. As a beginner, you will want to start with a demo before diving into the actual platform. Most brokers offer a free demo account for practice. When choosing a demo account, start with a Metatrader or MT4 platform because most live accounts use the same software. After mastering it, you can move on to alternative trading software.
Using charts efficiently
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What to look at when you start
Study the hourly chart to determine the big picture. Note marked support and resistance points within 2% of the day’s opening rate.
Look at the 15-minute chart carefully and take not of the following :
- Main trend
- Current price in comparison to the 60 period Simple Moving Average (SMA)
- High and low positions since 00:00 (GMT)
- Top and bottom positions in the full three-day period
How to work with the information obtained so far
Establish the big picture for intra-day trading
By looking at the 60-minute (hourly) chart, you can get an idea of the trading perspective- whether up or down. If it is not immediately clear, then you are probably within trading range.
Determine if the 15-minute chart validates the downward trend shown in the big picture.
The current price on the 15-minute chart should be less than the 60 period moving average and the moving average line should be in a decline direction. If so, then you can establish that the main trend is a downward position.
There are usually two trends, a main trend and a minor trend. The minor trend is the reverse of the main one, and occurs for only a short period. Minor trends can be easily seen on 5-minute charts.
Identify the current trend (whether main or minor) from the 5-minute chart
If the current price on the 5-minute chart is higher than 60 period SMA and the moving average line is inclined upward, then it is a minor trend.
Trading with information collected
By now you will know the following:
- The direction of the main trend
- Whether you are presently trading with the direction of the main trend or merely facing a minor trend (knee-jerk response to the main trend)
Likely trade scenario
Imagine the main trend is down and you are in a minor upward trend. The strategy to take will be to sell when the price on the 5 minute chart is lower than the 60 period moving average, and the 60 period moving average line is on a downward slope. This is because the main trend is reaffirming itself and it is likely to go down next.
Is there anything you can do further? Yes, observe the chart for more validation. For instance, if the minor trend has stayed for some time, and the last half hour (or hour) lows are near the 5 minute moving average, then it is much better to enter the market by selling just under the half-hour lows than just below the moving average line.
As you continue to practice, your understanding of the charts will improve. Hopefully, you are better trader now than you were before reading this guide.