Understanding these concepts will make all the difference in your Forex trading career. It will give you the ability to trade based on what the market is expressing through price action. This resource can be useful to shift through the mountain of news and information that is produced every day and trade what you really see on the charts.
This chapter attempts to explain that there are no secrets when it comes to exploring the foot print of exchange rates across a chart. Nevertheless price action is more than just swing highs and swing lows.
Rest assured this chapter will not leave you in the dark. Although obvious, this concept is rather abstract and requires some practice to be effectively used. Understanding a concept from a theoretical point of view is not synonymous with having integrated it into the practice. This section breaks down the dynamics of price action, and with the help of lots of charts , you will thoroughly understand this concept and learn how to trade with it.
This new knowledge will make you see the charts with a new sense of objectivity and trade in a much more relaxed and proactive manner. The reactions of traders towards the market is what moves the exchange rates. These, in turn, reflect all the information: There is no inherent logic to the market nor a higher intelligence that can be decoded. It is rather the opposite: They are more likely to vacillate between periods of greed and periods of fear. There are so many market participants and so many reasons why each one of them decides to buy or sell at a given moment that no system would be capable of decoding this mass behavior considering all its variables.
Commonly, it is said that chartism , by its very nature, is more an art than a science. This is a correct postulate if we consider that markets are made by human beings and not by analytical methods. All traders, in some way, pay attention to price levels but the way they react to them is never exactly the same. Becoming a trader requires you to learn how to behave in such an unpredictable environment. It's essential to create a strategic framework with which identify the behavior patterns made by market participants.
This knowledge will give the trader a statistical advantage to act upon the market. To start developing your analytical skills, it is essential to be able to identify supply and demand levels and to measure their strength. One of the advantages of supply and demand levels is their consistency and the fact that they remain visible in a chart for days, weeks, and in some cases for months and years.
Not surprisingly, most trading manuals start by shedding light on this issue as it's one of the pillars of technical analysis. By its logic, it's a simple concept to understand, however, it's also where most inexperienced traders fail. Who has not opened a position and seen how the market immediately turned in the opposite direction to finally liquidate it at the stop loss?
To compound the problem: The PFX Team invites you to take a step back to economics to make sure you understand the subject:. Supply is the measure of how much of a particular commodity is available at any one time. As the supply of a currency increases, the currency becomes less valuable. Conversely, as the supply of a currency decreases, the currency becomes more valuable. On the other side of the economic equation, we find demand. Demand is the measure of how much of a particular commodity people want at any one time.
Demand for a currency has the opposite effect on the value of a currency than does supply. As the demand for a currency increases, the currency becomes more valuable. Conversely, as the demand for a currency decreases, the currency becomes less valuable.
To illustrate how supply and demand interact to determine an ideal exchange rate in the Forex market, we are going to use a standard supply and demand graph. Supply is represented by a diagonal line that is sloping up from a low point at the left end of the line to a high point at the right end of the line.
Demand is represented by a diagonal line that is sloping down from a high point at the left end of the line to a low point at the right end of the line. Finally, the ideal exchange rate is represented by the point where the two diagonal lines intersect. Next, Sam Seiden recalls what are the basic conditions in a free floating currency market:. The foreign currency Forex market is where global exchange rates are derived for everyone including market speculators and end users of currency.
People and companies buy and sell currency much like you would buy and sell anything else. Strong economies have strong currencies. When we trade the Forex markets, we are trading economies. Therefore, supply and demand for currency depends on the current and expected perceived health of a country's economy. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values based on pure supply and demand for currency.
In another article, Sam Seiden resumes the main principles which characterize today's financial markets. The first principle states that "Price movement in any free market is a function of an ongoing supply and demand relationship within that market". The second law states that "Any and all influences on price are reflected in price.
Our goal is to quantify those forces and identify price levels where the imbalance is greatest as this creates change, or movement in price. A support level is a price level below the current one, where the demand was stronger than supply , driving the price upwards. Demand is synonymous with bullish , bulls and buying. At a support level , general expectation dictates that demand will outstrip supply , so a fall in price would be slowed down by the time price reaches that level. Consequently the price is expected to bounce back upward because support is the price level at which demand is thought to be strong enough to prevent the price from declining further.
The market, understood as the will of millions of investors, considers a price level low enough and acceptable to purchase, so when the price reaches that value, purchases soar. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy.
As demand increases, prices advance higher. On a chart , a resistance level is an identified maximum level where the supply has exceeded the demand , stopping the upward momentum in the exchange rate , and eventually making it drop from there.
Supply is synonymous with bearish , bears and selling. If the market believes that a price level is very high, sales soar at the time price reaches that value. In other words, a resistance level is a reference price where selling pressure is greater than the demand.
In many cases this pressure is so great it can halt the rapid escalation of prices. The levels of support and resistance are detected primarily by analyzing the evolution of price action on a chart and identifying where prices halted after a rising or falling period.
Resistance thus is the price level at which selling pressure is expected to be strong enough to prevent the price from rising further.
The logic dictates that as the price rises towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. When the price reaches the resistance level , it is believed that supply will overcome demand and prevent the price from rising above it.
In this lesson and adjacent video of the Forex Essentials Course, the PFX team shows different chart types by looking at support and resistance levels. Additionally, James Chen provides us with valuable information about another type of charts , the Point and Figure , to visualize price action:. This is because only price, which is undeniably the most important aspect of technical analysis, is customarily included on this type of chart in the form of X's and O's.
This leaves only the uncluttered purity of price action. In another blog post James also speaks about a variation of the Japaneese Candlestick charts , the Heikin Ashi:. The distinct look of Heikin Ashi charts is noticeable on the very first glance. During trending periods , virtually uninterrupted series of solid or hollow candles are the rule. This means that even during minor retracements in a strong trend , Heikin Ashi charts will essentially show a one-directional run.
Therefore, during these trending periods , Heikin Ashi charts work their best in indicating whether a trend has ended or is still intact.
As you notice, there are different ways to visualize price action. Important for you to know is that all price actions as you see on the charts are derived from market participants buying and selling currencies. Despite the fact there are several ways to capture price action on a chart , we make use of Japanese candlesticks throughout the chapters of the Learning Center. If you have read texts on chartism , then you already know the saying: And vice versa, when support is broken down, we are in a down trend and support becomes resistance.
A simplistic explanation such as: The truth is that it works" or "This works because everyone uses it" should not suffice when seeking to understand the dynamics of supply and demand.
The concept of support and resistance is quite easy to understand, and it has some components which will improve your chart analysis: Also the time factor is an important ingredient in the analysis and should be also considered. This Unit and the Practice Chapter A thoroughly deal with both aspects. Let's start to visualize the potential amount of supply and demand on a chart. Similarly, we see from the chart below that demand decreases as the price rises after bouncing at the low level of 0.
A support level is a price level considered attractive by a large number of buyers. If the demand to buy a given currency is high enough higher than the willingness to sell , a downward move in the exchange rate will eventually slow down and even reverse. This is what happened around the 0. Does this happen always? Well, not always but it happens with an astonishing high frequency. James Chen tells us more about what is usually called a self-fulfilling prophecy:.More...