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A forex beginner’s guide to technical analysis
Learn how to use wave-trading, trendlines and moving averages plus how to manage your level of risk when trading.
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Choosing a strategy can be very difficult when you first start trading forex and CFDs. This guide outlines 3 of the main forex trading technical analysis strategies you could consider, as well as some risk management techniques to help limit your losses.
If you’re looking for an online trading platform, you can compare forex brokers at the end of this guide as well.
Understand how different markets move
Many markets trade differently and move in various cycles. Before you devise a trading strategy, you’ll need to be familiar with how each asset class behaves.
Equity markets tend to trend for longer since an investor in equity markets will likely be looking for long-term returns and retirement income. Currencies tend to be more volatile and dynamic and tend to revert to mean (moving back to a more normal area).
The foreign exchange market, or FX, is a great market to trade but tends to be more sensitive than equities, while commodities run in a more cyclical pattern due to harvesting and mining cycles. For example, grains tend to follow weather and demand patterns. Coffee is used all year round but futures from different markets follow harvesting cycles in their respective regions.
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Disclaimer: Trading CFDs and forex on leverage is high-risk and losses could exceed your deposits.
Trading strategy 1: Technical-based moving average
This strategy can help traders spot long-term price trends by considering the average trend over a period of time rather than focusing on the day-to-day price movements.
This strategy can help you control risk easily and has a strict entry point. You can choose the time frames yourself, but be aware that trading on shorter time frames involves more risk as prices can be more volatile and your stop-loss can cancel you out of your position quickly.
Start with a 4-hour candle chart and add a 30-period moving average (an average of the last 30, 4 hour periods). Now each time the price crosses the moving average in either direction, you take a position. The stop loss should be placed at the previous wave’s low/high.
Image source: Screenshot taken from author’s own trading platform
The chart above highlights the basic premise of the strategy. The long position (Buy) on the left hand side of the chart, the stop loss (risk limit) at the bottom left of the chart and then finally at the top right shows the exit of the trade, where the price crosses back below the moving average. So in essence when the price moves above the line (moving average) in this strategy it’s a buy signal and when it moves back below we sell out and take profits.
Trading strategy 2: Wave trading
Wave trading is when you trade pullbacks in a trending market. A pullback is when there’s a slight dip or drop in the price of an asset that has been trending upward, and often can be a good opportunity to start a position. First of all, you need to establish a trend. You can do this by looking at the closing prices each day over a period of time. If the market you have chosen has made higher highs and higher lows, it’s on an uptrend. If it’s made lower highs and lower lows, it’s in a downtrend.
Once this has been established, the trick is to look for an entry point on the next wave up or down depending on the direction. To some investors, it can be difficult to buy a security at the highs, but to many seasoned investors, this is a common strategy to follow momentum and hold positions for a significant period of time.
Let’s looks at the ASX as an example in the following chart.
Image source: Screenshot taken from author’s own trading platform
In this chart, the highlighted area at the top has to be broken for a position to be added. You can see the ASX index has been trading in an uptrend, and following this trend could be beneficial.
Risk can be determined by the size of your position and where the previous waves begin. In the above example, a stop has been suggested around half way into the trend. This could possibly be sufficient to achieve a decent risk to reward. However, if you have a higher tolerance to risk, you could place the stop lower down to before the waves begin in the uptrend.
To help limit your risk with this trading strategy, you could start with a smaller position, and when each wave high is broken, add more to the position as desired.
Trading strategy 3: Trendlines
Trendlines are an important indicator of the market’s underlying trend. Once a trendline is broken, this can be a reference point to future prices. Determining the trendline and drawing it correctly is the hard part. Similar to wave trading, a trendline can be drawn by looking at the previous closing prices over a set period of time. If each closing price is lower than the previous, it could signal a downtrend. All price action must be under the line (none of the price action must be above the line when drawing a down trendline and vice versa for an uptrend).
Let’s look at this gold daily chart as an example.
Image source: Screenshot taken from author’s own trading platform
As you can see, there is a very steep down trendline plotted in the middle of the chart. The buy signal is triggered on the break of the trendline. Because the trend has been broken, the trader assumed the price would now continue in an upward direction instead, which you can see it did for a short period.
However, after a short time, the price quickly went down again, which is when the stop was executed and the position was closed at a loss. For this reason, you can see this particular trade didn't work out. As a trader, you must be prepared to take losses as not all trades go to plan.
Risk management strategies
Risk management is key to all forex trading strategies; you cannot control the future, but you can control your risk! These are some simple risk management techniques you can follow:
- Limit your capital. Making more frequent trades of less value rather than larger trades less often could be a good way to limit your risk.
- Diversify your trades. You may want to consider not taking too many trades that are correlated to each other. Take for example, long (buy) EUR/USD and short (sell) gold. If the US dollar appreciates too quickly, EUR and gold could both fall in tandem and take you out of both positions.
- Consider the size of your positions. Some brokers only offer minimum and maximum trade sizes on different asset classes. For example a EUR/USD position may be able to trade with a $1 per point size (1 decimal movement in price) but a silver position may have a minimum of $4. Even if you are correct with your trade decision, this over-leveraging may make the trade uncomfortable and force unwanted account management.
Having a clear trading plan and strategy in trading is probably the most important, and toughest, aspect for any trader to establish. This could be the difference between success and failure. Once you are confident with the strategy you have chosen, back-test it (run a simulation). There is software that can do this for you, for example tradingview, but you can also do it manually.
Demo trading is also another way to see if you have a handle on executing the plan and controlling the money management. Obviously, you cannot win every trade, but if you control the risk to reward and account management, you will be at least half way in the right direction.
Your personal psychology is also something you need to consider. If you can't stare at your charts all day without messing with your positions, maybe a “set and forget” strategy on a long-term time frame would be better. If you enjoy the adrenaline, then a short-term system would suit you.
Compare forex and CFD trading platforms below.
Compare Australian forex and CFD brokers below to find one that meets your trading level and needs.
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
Trading CFDs and forex on leverage is high-risk and you could lose more than your initial investment. It may not be suitable for every investor. Refer to the provider’s PDS and consider the risks before trading.
Important: Share trading can be financially risky and the value of your investment can go down as well as up. “Standard brokerage” fee is the cost to trade $1,000 or less of ASX-listed shares and ETFs without any qualifications or special eligibility. If ASX shares aren’t available, the fee shown is for US shares. Where both CHESS sponsored and custodian shares are offered, we display the cheapest option.
Disclaimer: This information should not be interpreted as an endorsement of futures, stocks, ETFs, CFDs, options or any specific provider, service or offering. It should not be relied upon as investment advice or construed as providing recommendations of any kind. Futures, stocks, ETFs and options trading involves substantial risk of loss and therefore are not appropriate for all investors. Trading CFDs and forex on leverage comes with a higher risk of losing money rapidly. Past performance is not an indication of future results. Consider your own circumstances, and obtain your own advice, before making any trades.
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Ask an Expert
Does it cost $100 per day to leave a trade open longer than a 24hr period?
Hi Chris,
Thanks for getting in touch with Finder. I hope all is well with you. 😃
Regarding your question, that you would depend on the trading platform you are using. Thus, it would be a good idea to check your trading platform for any fees that may apply if you leave a trade open for longer than 24 hours.
I hope this helps. Should you have further questions, please don’t hesitate to reach us out again.
Have a wonderful day!
Cheers,
Joshua