Defining Moments Regarding
Trading Trends and Ranges with Forex
One of the ways forex traders determine when to buy or sell is by a method known as technical analysis. While some traders use a method called fundamental analysis, which employs factors such as politics, current events, and the state of world economies, technical analysts are concerned solely with prices past and present. By using formulas and calculating various lines and indicators, these traders are able to project into the future and make an educated guess as to what the price of a given currency will do. And nearly all of these indicators have certain defining moments that tell one when to act.
With the Moving Average Convergence / Divergence (MACD), a technical analyst plots on a price chart two lines representing closing price moving averages of different lengths, typically 12 and 26 days. The MACD line is plotted using the difference between these two moving averages, and a second line called a “signal” is formed by taking a nine day moving average of the MACD line. It is the interaction between these two lines that create triggers telling the trader when to act, and one of these defining moments comes when the lines cross, as it indicates that there will likely be a change in trend. When the MACD line crosses up through the signal line, this is the trigger to buy, and one should sell when the signal line crosses up through the MACD line.
Another tool that technical analysts use to determine when to buy or sell is the Relative Strength Index (RSI), which indicates price strength. Fairly easy to calculate, this indicator measures the ratio of up days to down days in a currency. Since the forex market is open 24 hours, most analysts use the price as it was at the close of the New York Stock Exchange for that day. To arrive at the RSI, one measures the amount of change up or down each day, and then calculates one exponential moving average each, typically of 14 days, of the up numbers and down numbers. A fraction is formed by using the up moving average as the numerator and the down moving average as the denominator. This fraction is then represented as a number from 1 to 100. Essentially, a high RSI indicates the currency has been bought more than sold lately, and vice-versa. One defining moment in the RSI line comes when it reaches 70, which is the number that most analysts feel represents an overbought currency and one that should be sold. Likewise, an RSI of 30 or below indicates a currency that is ripe to buy, as it is oversold.
On a more long-term scale, a Coppock Curve is a tool often used by technical analysts to determine when a bear market has reached its low. Designed to use on a monthly scale, this line is calculated by adding a 14 month rate of change with a 10 month rate of change, and smoothing it with a weighted moving average. A signal to buy is generated when this number is below zero, and moves upward from a trough, as this represents the end of a long period of selling. This tool is psychological in origin, as its creator likened bear markets to period of mourning. Upon asking members of the Episcopal Church the length of time a typical person mourns, he received an answer of 11 to 14 months, so he used these numbers in his formula.
By following certain trends and acting when triggers are indicated, many technical analysts are finding success in the forex market. These defining moments are times when it is best to act, whether the signal generated is to sell or buy.