How to read Forex charts
Reading time: 9 minutes
It is no secret that Forex trading can be performed more efficiently if you possess the necessary tools. When you have a certain amount of experience and proficiency in currency trading, it would be a good decision to discuss the tools which Forex traders regularly utilise. Owing to the leverage and the fast paced nature available in FX trading, a lot of Forex traders do not hold particular positions for a very long time period. For instance, FX day traders can commence a huge number of trades within a single day and may not actually hold them for longer than a few minutes each. In the situation where a Forex trader deals with such small time horizons, viewing a chart and applying technical analysis are convenient tools. That is because a chart, as well as associated patterns can define a wealth of information in the simplest terms. The purpose of this article is to get you acquainted with certain charts and guide you on how to read Forex charts. We will look at candlestick charts, trends and 'head and shoulders'.
The way to read candlestick charts
The candlestick chart is a variant of charts that have been used for approximately 300 years and it reveals more information than a traditional line chart. The candlestick is just a thin vertical line that represents the range of the trading period. In turn, a wide bar on this vertical line represents the distinction between the open and close.
In addition, the daily candlestick line consists of the currency's value at open, low, high and close of a peculiar day. The wide part of the candlestick has a specific name - the real body. The real body illustrates the range between the open and close of that day's trading. When the real body is either filled in or black, it implies that the close was lower than the open. If the real body is empty, it implies exactly the opposite - the close was actually higher than the open. By understanding this, you will understand better how to learn to read Forex charts.
What is above and below the real body are called shadows. As a matter of fact, chartists have always regarded these as the wicks of the candle and it is the shadows which represent the high and low prices of the day's trading. When you observe the upper shadow, or the top wick on a down day being short, the open that day was actually closer to the high of the day. When there is a short upper shadow on an up day, this tells us that the close was near the high. In fact, the relationship between the day's open, close, low and high identify the true look of the daily candlestick.
When you see a series of candlesticks, you are capable of seeing another significant concept of Forex charting - the trend.
The approach of understanding trends
When a group of data points are plotted on a chart, you might start seeing a general direction in which a currency pair is moving towards. As you understand, there can be different instances or circumstances. In some of them the trend is quite easily defined, while in others it is much more complicated to determine a trend. Trends are usually inclined to operate in a series of steadily moving highs and lows. Therefore, an uptrend is actually a sequence of escalating highs and lows. In turn, a downtrend is a succession of descending lows and highs.
Generally there are three types of trends - downtrends, uptrends and also sideways or horizontal trends. Knowing them is an important part of Forex trading chart analysis. Some chartists perceive a sideways trend as not actually being a trend on its own, but rather a deprivation of a well-determined trend in each direction.
Just as there are three trend directions, there are three classifications of the trend in the context of time duration in which a trend is taking place. The trend of any direction can be categorised as either a long-term trend, an intermediate trend and a short-term trend. The short-term trends are in fact a combination of elements of both major (long) and medium trends.
What trendlines actually mean
As for this part of Forex chart analysis, trendlines demonstrate a particular charting technique in which a line is added in order to show the trend in a currency pair. Frankly speaking, drawing a trendline is just as easy as drawing a straight line that follows an overall trend. Additionally, trendlines can be used to define trend reversals.
An upward trendline is actually drawn at the lows of an uptrend. Likewise, a downtrend trendline is drawn at the highs of the downward trend.
It is essential to comprehend and detect trends so that you are able to trade and profit from the overall direction in which a particular currency pair is heading, rather than lose money by unwisely acting against them.
Understanding 'head and shoulders' and how to read them
The head and shoulders pattern is one of the most widely used and reliable chart patterns - and you can observe it when looking at your online Forex trading charts. The ordinary head and shoulders top pattern is actually a signal, where a currency pair is set to fall as soon as the pattern is fully complete and is frequently formed at the peak of an upward trend. Furthemore, a second version known as the head and shoulders bottom, notifies that a security's price is set to rise and generally forms during a downward trend. In either instance, this chart pattern indicates a forthcoming reversal, so this implies that a currency pair is likely to move against the preceding trend.
The neckline meaning
Both of the head and shoulders patterns have a similar construction in that there are four main parts to this chart pattern - i.e. two shoulders, a head and a neckline. The patterns are actually confirmed when the neckline is broken, later than the formation of the second shoulder. The head and shoulders are a series of peaks and troughs. In turn, the neckline is a level of either support or resistance. Knowing all that is a good supplement to your knowledge of how to analyse Forex charts. For instance, an upward trend is seen as a period of consecutive rising peaks and rising troughs. On the other hand, a downward trend is a period of descending peaks and troughs. All in all, the head and shoulders pattern demonstrates a weakening in a trend where there is a decline in the peaks and troughs.
The head and shoulders top
This pattern has four key sequential steps for it to complete itself and consequently signal the reversal.
- The left shoulder formation takes place when the security achieves a new high and then retraces to a new low.
- The head formation of this pattern relatively to one of your Forex charts online, happens when the security reaches the higher high and then descends back near the low formed in the left shoulder.
- The right shoulder formation formed with a high that is relatively lower than the high formed in the head. It is again followed by a fall back to the left shoulder's low.
- When the price descends below the neckline, or when the price descends under the support line formed at the level of the lows achieved at every of the three lows (mentioned above).
The head and shoulders bottom
As you understand, this is the opposite of the head and shoulders top as it determines that the currency pair tends to make a move upwards.
We will present four steps to this pattern, which you can see if you look at your online Forex charts.
- The left shoulder formation takes place when the price originally descends to a new low and then eventually rallies to a high.
- The head formation happens when the price heads to a low that is under the previously mentioned low of the shoulder, followed by a particular return to the foregoing high. This step back to the preceding high creates the neckline for this chart pattern.
- The right shoulder formation. This is commonly a sell-off that is quite less severe than the one from the preceding head. And yes, this is followed by a return to the neckline accordingly.
- The currency pair breaks above the neckline. The pattern is complete when the price heads above the neckline originated by the foregoing heads and shoulders.
The actual breaking of the neckline and the potential return movement
After the neckline is broken, the currency pair should be moving in a new direction. You are able to observe that if you look at your Forex chart online. Exactly at this point, the majority of traders following the pattern would enter into a particular position.
Nonetheless, there is one possible scenario where this may not occur and the currency pair eventually returns back to the preceding trend. A throwback move occurs when the price breaks through the neckline, setting either a new high or low, but then goes back to the neckline.
Since it can be an issue to observe a currency pair return to its original trend, it may not be a serious concern. In fact, the throwback could be a successful test of the new level of either resistance or support. This would eventually help to amplify the pattern and further confirm its new trend. A certain amount of patience is needed to wait for the pattern to play out and to not close the position out too hastily - prior to the pattern making its bigger moves. Now you know how to read a Forex chart.
We have made this guide in order to uncover some of the core technical analysis tools which are utilised by Forex traders. Candlestick charts are widely applied as they can expose a wealth of data in a blink of an eye. Discovering a currency pair's trend may be a good indicator of where it can go in the near future. In addition, chart patterns can be used to predict and then confirm upcoming trends. For instance, the head and shoulders pattern can define that a particular currency pair will be experiencing a reversal in its trend. As you can see, understanding Forex charts, as well chart patterns is a considerable part of FX trading.