Part 5 - Learn Forex Trading: How to Read Chart

November 19, 2009 | scorpion

For the newbie trader Forex trading often appears as an esoteric subject. With all the psychedelic colors that appear on the trading screens you would easily start wondering if forex trading can indeed be done by ordinary people. That could well be the case when you open out forex charts as an adjunct to your trading screen, especially as it has a lot to do with lines and colors. But as a matter of fact, forex charts are very easy to learn and doesn’t require any special mathematical skills whatsoever.

Let’s take a look at the 3 types of charts that is relevant to forex trading and learn how to read charts. Before we start looking at charts, one has to understand the concepts of fundamental analysis and technical analysis. Both these concepts are used to analyze currency markets and forecast the direction of future currency price movements.

Fundamental Analysis and Technical Analysis

Fundamental analysis deals with economic, social, and political forces that drive supply and demand of currencies and how price movements take shape on account of the same. On the contrary, technical analysis means studying currency price movements by itself in order to make a prognosis of future currency price trends. A currency “chart” is quite simply a tool used in technical analysis.

Forex investors can use both types of analysis to make trading decisions. But the surmises based on technical analysis is what makes you open or close deals, its all the more important to be able to read charts. In short charts as mentioned earlier are an important tool in technical analysis.

What is a currency chart?

A chart tells you the sum total of what’s happening in the market as a graph of the prices of a currency pair over a fixed period of time. You can call it a visualized representation of currency price movements, as a result of activity that goes on between buyers and sellers in the currency market. Forex charts tell a clear picture of whether a pair of currencies is getting stronger or weaker so that you can make your trade likewise.If it is the currency pair EUR/USD, a chart for the day can offer much insight in terms of price levels and general market trends. Therefore it is an indispensable tool for any currency trader.

So coming back again to the three different types of charts, you can classify them as: bar charts, candlestick charts, and line charts.

Let’s get to analyzing each of these charts and how to read them.

Line chart

A currency line chart is a line that connects different closing prices. These connected prices show the price trend of a particular currency over a specific time frame. As it simply connects the closing price with a line, just glance at the line chart and you get a feel of the market.

Below is an example of a line chart. Take note that a line chart clearly and simply shows the direction of the trend.

Forex EURUSD Line Chart

The base of the chart gives the timeline. The right-hand side of the chart shows the currency values that generally run from a little below to a little above the lowest and highest prices reached during the time period specified.

For example, in the EUR/USD chart shown above you can see how the US dollar and Euro have moved against one another during the period for which the chart is plotted. Similarly a forex chart can be created for any single currency pair like the EUR/USD, USD/JPY and so on plotted over a period of time.

Before you read the chart first select the time frame for the chart as for example a short time scale can help you discern minor trends while a long time scale can help you to see long term trends. When doing forex trading it is best to refer to the charts as published in the trader’s platform. For example if you are trading through a broker such as fxcm look at their charts to trade and so on.

But the problem with line charts is as for example if the market were to move abruptly/drastically all the line chart shows is the close, which means you could miss out on vital information that is crucial to either making or loosing money as a trader. In other words line charts only measure the overall direction of long-term trends (by measuring closing price for a series of periods), and hence are of limited use.

Bar chart

A bar chart gives a bit more information than a line chart in that it gives you the open, close, high, and low of the market for a particular currency pair. In effect it gives you more data about the price changes that happen during the bar, not just at one point in time.

Bar charts are also referred to as “OHLC” charts. In OHLC the individual letters denotes Open, High, Low and Close for that particular currency pair.

Have a look at this example of a price bar:

Forex One Bar of Bar Chart

OPEN: The horizontal line on the left stands for the opening price of the currency

HIGH: The top point of the vertical line shows the highest price of the currency during that time period

LOW: The bottom point of the vertical line shows the lowest price of the currency during that time period

CLOSE: The horizontal line on the right shows the closing price of the currency.

Essentially a bar chart conveys four key pieces of information for any given time frame. They are the opening price during that time frame; the closing price; the high price; and the low price. As bar charts can be used for all time frames, it could summarize price activity, say over the past minute, hour, day or over the past month. Looking at the chart for example you can figure out when exactly the markets moved quickly.

Have a look at this example of a bar chart for the currency pair EUR/USD.

Forex EURUSD Bar Chart

Here’s how a bar chart is interpreted:

Read bar charts from the left side to the right side. The bottom of this vertical bar indicates the lowest traded price for that time period, while the top of the bar indicates the highest traded price. Therefore the individual vertical bars in the chart above by itself indicate the currency pair’s trading range as a whole. The horizontal tick on the left side of the bar is the opening price, and the right-side horizontal tick is the closing price for that time period.

In effect they offer more data about the price changes that happen during the bar, not just one point in time as in line charts.

Candlestick chart

Candlestick charts were invented by the Japanese in the 1700s to study the movements in the price of rice on Japanese commodity exchanges. Candlestick charts show the same information as a bar chart but in a graphically attractive way.

Candlestick bars indicate the high-to-low range with a vertical line as in any bar chart. But in candlestick charts, the larger block in the middle indicates the currency price range between the opening and closing prices.

Now consider this candlestick bar that is all colored up.

Forex One Candle of Candlestick Chart

The red or green portion of the candlestick is called the “real body” or “solid body. “The “real body” of the candlestick represents the range between the opening price and the closing price for a particular time frame. Real bodies can be either long or short.

The center of the bar on the left side is green in color and the center of the bar on the right side is red in color. What this means is, if the currency “close” price was lower than it opened, the candlestick would be red in color. On the contrary if the currency “closed” price was higher than it opened the candlestick would be green in color. But in a situation where the closing price is higher than the opening price, the “middle” block is green in color.

The “wicks” above and below the candlestick are called shadows and is where the price dipped or rose to reach a price, albeit transiently although it did not stay at that price. Shadows can be long or short. If the upper shadow on a green candlestick is short it indicates that the close was near the high.

Take look at this example of EUR/USD candlestick chart.

Forex EURUSD Candlestick Chart

This means that if the price closed higher than it opened, the candlestick would be green. If the price closed lower than it opened, the candlestick would be red. The look of the daily candlestick depends on the link between the day’s open, high, low and close prices. For example, if the upper shadow of the red candlestick is short it indicates that the open that day was closer to the high of the day.

In the final analysis candlestick charts serve as a visual aid, and the information you get from them is no different from what you would get from an OHLC bar chart.

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