Currencies: how to turn yourself into a chartist
By
Dominic Frisby Mar 19, 2010
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Technical analysis using charts is a useful tool for timing trades. But you needn't get bogged down in all the details and jargon. Dominic Frisby discusses the basics.
Many of the principles of stock trading apply equally to currency trading. I like to use a healthy mix of fundamental and technical analysis. As John Stepek points out in his article Where to place your bets in the currency markets, each currency is affected by a mixture of fundamental factors. The Australian and Canadian dollars, for example, tend to rise and fall with commodity prices. The British pound, meanwhile, tends to follow the fortunes of Britain's all-important financial sector.
But what about timing your trade? This is where technical analysis comes in. It can be as easy or as complicated as you make it. So don't worry if you can't tell your oscillators from your stochastics – you don't need to understand them. What you do need to know is what timeframe you're trading in. If you are day trading, for example, long-term macro calls, such as "the Canadian dollar should rise because of declining global oil reserves", are irrelevant. Similarly, if you're looking at a three-year picture – sterling's downtrend, say – then the fact that Gordon Brown might have made some noises last week about cost-cutting that sent the pound higher, is also irrelevant.
Once your timeframe is decided, you need to draw up a relevant chart. If you are day trading, you might look at daily, hourly, or even 15-minute charts. If you are making a longer-term call, you might prefer a weekly, or even a monthly, chart. Lots of sites offer free, easy-to-use charting software (see below for more).
Of all forms of chart analysis, the simplest and best is the straight line. It can help you identify trends, channels, entry and exit points, where to place your stop, likely points of support and resistance, and lots more.
Take a look at the first chart below.
It's a 20-year monthly chart of the pound. I've drawn three horizontal lines on it. They show graphically what most people will already know: that there is a great deal of resistance at the $2 mark (blue line) – that's where to sell sterling and buy US dollars. There is a great deal of long-term support at the $1.40 mark (red line) – that's where you would sell dollars and buy sterling. And there is a great deal of both support and resistance at the $1.70 mark (green line). In bear markets, this level has acted as a ceiling through which sterling can't break – the 2009 rally petered out here. And in sterling bull markets it has been the floor at which sterling has found support.
But this does not really help the trader. Sterling has only tested the $1.40 level of support three times in the last 20 years: in 1993, 2001-2002 and 2009. So you'd have been waiting a long time for your entry point. It's only tested the $2 mark three times: in 1991, 1992, and from late 2006 to mid-2008, when it hovered around that area. So if you had sold (gone 'short') sterling in 2006 at $2, you'd have had to wait two years to see real gains.
So let's shrink the timescale a little. If we look at a three-year chart (below), again we see the importance of those three levels.
Based on these lines, sterling is a sell above $1.65 and a buy at $1.40. You would place your stop (the level at which your bet is closed, saving you from further losses if the trade goes against you) above $1.70 and just below $1.35.
Let's get even closer and look at a one-year chart (below).
I hate to speak ill of the currency of our great nation, but that is one ugly chart. I have left on the red and green lines to show the long-term points of support and resistance. The black lines show a channel that was forming since the summer. You might have sold sterling at the top of the channel and bought back at the bottom of the channel, leaving stops somewhere just beyond the channel. In late February, when it emerged that a hung parliament was a real possibility, sterling broke down through the channel. Your stop placed just below the black line would have been triggered.
Now we have another channel in place, shown by the purple lines. This is a short-term channel, but again we can trade from it. You might sell sterling at $1.52, but put a stop just above at, say, $1.535, hoping the channel will hold. If it doesn't, and your stop is triggered, you might look for sterling to rally back to the black line and bounce off it. In which case you might look to sell at $1.55 with a stop at either $1.58, or just above $1.60.
Where can I learn more?
Among the UK sites offering free charting software, www.digitallook.co.uk is worth considering. For my own charting, I use www.bigcharts.com for companies; www.futuresource.com for commodities and forex; and www.stockcharts.com for indices. Stockcharts is free but also offers an excellent premium service. Many of these sites also offer useful tutorials in technical analysis.
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