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.
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:
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.
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.
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.
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.
