Technical Analysis

Technical analysis helps in the prediction of future market movements (that is,
changing
in currencies prices, volumes and open interests) based on the information obtained
from
the past.
There are different kinds of charts that help as tools for technical analysis.
These charts
represent the price movements of currencies over a certain period preceding
exchange
deals, as well as technical indicators. The technical indicators are obtained
through
mathematical processing of averaged and other characteristics of price movements.
Technical Analysis (TA) is based on the concept that a person can look at
historical price
movements (for example currency) and determine the current trading conditions and
potential price movement.
Dow Theoryfor Technical Analysis
The fundamental principles of technical analysis are based on the Dow Theory with
the
following main assumptions:
Price discounts everything
Price is a comprehensive reflection of all the market forces. At any point of time,
all market
information and forces are reflected in the currency price (“The Market knows
everything”).
Prices usually move in the direction of the trend
Price movements are usually trend followers. There is a very common saying among
traders – “Trend is your friend”.
Trends are classified as –
 Up trends (Bullish pattern)
 Down trends (Bearish pattern)
 Flat trends (sideways pattern)
Price movements are historically repetitive. This results in similar behavior of
patterns on
the charts.
Sentimental Analysis
The participants in every market, the traders and the investors have their own
opinion of
why the market is acting the way it does and whether to trade in the direction of
market
(towards market trends) or go against it (taking contrary bet).
The traders and investors come with their own thoughts and opinions on the market.
These
thoughts and opinions depend on the position of the traders and investors. This
further
helps in the overall sentiment of the market regardless of what information is out
there.
Because the retail traders are very small participants in the overall forex market,
so no
matter how strongly you feel about a certain trade (belief), you cannot move the
forex
markets in your favour.
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Even if you (retail trader) truly believe that the Dollar is going to go up, but
everyone else
(big players) is bearish on it, there is nothing much you can do about it (unless
you are
one of the big investment banks like – Goldman Sachs or some ultra-rich individual
like
Warren Buffet).
It is the trader’s view on how he is feeling about the market, whether it is
bullish or
bearish. Depending on this, a trader further decides how to play the perception of
market
sentiment into trading strategy.
What type of analysis is better?
Forex trading is all about trading based on a strategy. Forex trading strategies
help you
gain an insight of the market movements and make moves accordingly. We have already
studied that there are three types of analysis methods.
 Technical analysis
 Fundamental analysis
 Sentiment analysis
Each strategy holds equal importance and neither can be singled out. Many traders
and
investors prefer the use of a single analysis method to evaluate long-term
investments or
to gain short-term profit. A combination of fundamental, technical and sentimental
analysis is the most beneficial. Each analysis technique requires the support of
another to
give us sufficient data on the Forex market.
These three strategies go hand-in-hand to help you come up with good forex trade
ideas.
All the historical price action (for technical analysis) and economic figures (for
fundamental
analysis) are there – all you have to do is put on your thinking cap (for
sentimental
analysis) and put those analytical skills to the test.
In order to become a professional forex trader, you will need to know how to
effectively
use these three types of forex market analysis methods.
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The foreign exchange market is a global online network where traders and investors
buy
and sell currencies. It has no physical location and operates 24 hours a day for 5-
1/2 days
a week.
Foreign exchange markets are one of the most important financial markets in the
world.
Their role is of utmost importance in the system of international payments. In
order to
play their role efficiently, it is necessary that their operations/dealings be
trustworthy.
Trustworthy is concerned with contractual obligations being honored. For example,
if two
parties have entered into forward contract of a currency pair (means one is
purchasing
and the other is selling), both of them should be willing to honor their side of
contract as
the case may be.
Following are the major foreign exchange markets:
 Spot Markets
 Forward Markets
 Future Markets
 Option Markets
 Swaps Markets
Swaps, Future and Options are called the derivative because they derive their value
from
the underlying exchange rates.
Spot Market
These are the quickest transactions involving currency in the foreign exchange
market.
This market provides immediate payment to the buyers and sellers as per the current
exchange rate. The spot market account for almost one-third of all currency
exchange,
and trades usually take one or two days to settle transactions. This allows the
traders open
to the volatility of the currency market, which can raise or lower the price,
between the
agreement and the trade.
There is an increase in volume of spot transactions in the foreign exchange market.
These
transactions are primarily in forms of buying and selling of currency notes, cash-
in of
traveler’s cheque and transfers through banking systems. The last category accounts
for
almost 90 percent of all spot transactions are carried out exclusively for banks.
As per the Bank of International Settlements (BIS) estimate, the daily volume of
spot
transaction is about 50 percent of all transactions in foreign exchange markets.
London is
the hub of foreign exchange market. It generates the highest volume and is diverse
with
the currencies traded.
Major Participants on the Spot Exchange Market
Let us now learn about the major participants on the spot exchange market.
5. Forex Trading – Kinds of Foreign Exchange
Market
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Commercial banks
These banks are the major players in the market. Commercial and investment banks
are
the main players of the foreign exchange market; they not only trade on their own
behalf
but also for their customers. A major chunk of the trade comes by trading in
currencies
indulged by the bank to gain from exchange movements. Interbank transaction is done
in
case the transaction volume is huge. For small volume intermediation of foreign
exchange,
a broker may be sought.
Central banks
Central banks like RBI in India (RBI) intervene in the market to reduce currency
fluctuations of the country currency (like INR, in India) and to ensure an exchange
rate
compatible with the requirements of the national economy. For example, if rupee
shows
signs of depreciation, RBI (central bank) may release (sell) a certain amount of
foreign
currency (like dollar). This increased supply of foreign currency will halt the
depreciation
of rupee. The reverse operation may be done to halt rupee from appreciating too
much.
Dealers, brokers, arbitrageurs and speculators
Dealers are involved in buying low and selling high. The operations of these
dealers are
focused towards wholesale and a majority of their transactions are interbank in
nature. At
times, the dealers may have to deal with corporates and central banks. They have
low
transaction costs as well as very thin spread. Wholesale transactions account for
90
percent of the overall value of the foreign exchange deals.
Forward Market
In forward contract, two parties (two companies, individual or government nodal
agencies)
agree to do a trade at some future date, at a stated price and quantity. No
security deposit
is required as no money changes hands when the deal is signed.
Why is forward contracting useful?
Forward contracting is very valuable in hedging and speculation. The classic
scenario of
hedging application through forward contract is that of a wheat farmer forward;
selling his
harvest at a known fixed price in order to eliminate price risk. Similarly, a bread
factory
want to buy bread forward in order to assist production planning without the risk
of price
fluctuations. There are speculators, who based on their knowledge or information
forecast
an increase in price. They then go long (buy) on the forward market instead of the
cash
market. Now this speculator would go long on the forward market, wait for the price
to
rise and then sell it at higher prices; thereby, making a profit.
Disadvantages of forward markets
The forward markets come with a few disadvantages. The disadvantages are described
below in brief:
 Lack of centralization of trading
 Illiquid (because only two parties are involved)
 Counterparty risk (risk of default is always there)
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In the first two issues, the basic problem is that there is a lot of flexibility
and generality.
The forward market is like two persons dealing with a real estate contract (two
parties
involved - the buyer and the seller) against each other. Now the contract terms of
the deal
is as per the convenience of the two persons involved in the deal, but the
contracts may
be non-tradeable if more participants are involved. Counterparty risk is always
involved in
forward market; when one of the two parties of the transaction chooses to declare
bankruptcy, the other suffers.
Another common problem in forward market is - the larger the time period over which
the
forward contract is open, the larger are the potential price movements, and hence
the
larger is the counter-party risk involved.
Even in case of trade in forward markets, trade have standardized contracts, and
hence
avoid the problem of illiquidity but the counterparty risk always remains.
Future Markets
The future markets help with solutions to a number of problems encountered in
forward
markets. Future markets work on similar lines as the forward markets in terms of
basic
philosophy. However, contracts are standardized and trading is centralized (on a
stock
exchange like NSE, BSE, KOSPI). There is no counterparty risk involved as exchanges
have
clearing corporation, which becomes counterparty to both sides of each transaction
and
guarantees the trade. Future market is highly liquid as compared to forward markets
as
unlimited persons can enter into the same trade (like, buy FEB NIFTY Future).
Option Market
Before we learn about the option market, we need to understand what an Option is.
What is an option?
An option is a contract, which gives the buyer of the options the right but not the
obligation
to buy or sell the underlying at a future fixed date (and time) and at a fixed
price. A call
option gives the right to buy and a put option gives the right to sell. As
currencies are
traded in pair, one currency is bought and another sold.
For example, an option to buy US Dollar ($) for Indian Rupees (INR, base currency)
is a
USD call and an INR put. The symbol for this will be USDINR or USD/INR. Conversely,
an
option to sell USD for INR is a USD put and an INR call. The symbol for this trade
will be
like INRUSD or INR/USD.
Currency Options
Currency options is a part of the currency derivatives, which emerged as an
important and
interesting new asset class for investors. Currency option provides an opportunity
to take
call on Exchange Rate and fulfil both investment and hedging objectives.
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Factors affecting the currency option prices
The following table shows the factors affecting the currency option prices:
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There are many advantages of trading forex over trading in other market instruments
such
as equity and derivative. The benefits of trading forex has the following benefits:
Low cost
If we consider trading forex market spot, normally there is no clearing fees, no
exchange
fees, no government taxes, no brokerage fees and no commissions. Generally, retail
brokers make their profits from the Bid/Ask Spread, which is apparently very
transparent
to users.
No middlemen
In spot forex trading, there are no middlemen. It allows you to trade directly with
the
market accountable for the pricing of the currency pair (EUR/INR).
No fixed lot size
In the spot forex market, there is no fixed lot size for trading, though there is a
fixed lot
size which you need to trade, if you are trading in forex future or option market.
This is
one of the big advantages of forex trading. Generally, brokers provide the option
to buy
in multiple lot sizes as per your client requirement or convenience. Lot sizes
differ broker
to broker - standard lot, mini lot, micro lot or even nano lots. This enables you
to start
trading from as low as $50.
Low transaction costs
The retail transaction cost (bid/ask spread) is usually as low as 0.1% and for
bigger
dealers, this could be as low as 0.07%.
No one can corner the market
The foreign exchange market is large and has many participants, and no single
participant
(not even a central bank) can control the market price for a prolonged time period.
Therefore, the chances of sudden extreme volatility is very rare.
24-hours open market
We do not have to wait for the opening bell to ring to start trading in forex. The
forex
market starts, from the Monday morning opening of the Sydney session to the
afternoon
close session of New York session. This allows us to trade anytime we prefers
without
giving much attention on what time it is.
Use of Leverage and Margin
This is one of the factors, which drags more and more traders towards forex
trading. Forex
brokers permit traders to trade the market by using leverage and with low margin,
which
gives the ability to trade with more money than what is available in your account.
This
allows traders with less amount to trade with much higher value of trade. For
example, a