Graphical analysis refers to the practice of conducting technical analysis using information gleaned from the charts of the asset being traded. In the currency market, the assets traded would be currencies.
What does graphical analysis in forex entail? It entails using the forex charts to look for patterns that would tell a trader where the price action of the currency pair is likely to head to. There are various tools on the forex platform that are used for graphical analysis.
Some of these are as follows:
- Trend line tool
- Channel tool
- Fibonacci tool
- Pivot point calculators
These tools are used to look for the following patterns:
- Wedges (rising and falling wedges)
- Triangles (ascending, descending and symmetrical triangles)
- Channels (horizontal, ascending and descending channels)
- Tops and Bottoms (double tops, double bottoms)
- Areas of support and resistance
Using the Trend line Tool
The trend line tool is used to draw straight lines on the forex charts. The commonest use of the trend line tool is to plot areas of price highs and price lows. When plotting areas where prices make highs and lows, it is essential that the trend line tool is used to trace the line across at least two or three areas for accuracy. Thus the trend line tool can be used to spot wedge patterns, triangles, as well as areas of support and resistance when not using pivot points. Some experienced traders can also use the trend line tool to trace channels, but this requires very accurate visualization and should not be used by beginners or traders without much experience.
Using the Channel Tool
The channel tool is used to identify channels. Channels are formed when a trend line drawn across price highs is exactly parallel with a trend line drawn across the price lows. In order to plot the channel tool on the charts, all the trader needs to do is to drag the tool from the dashboard of the platform on to the candlesticks on the chart. The trader can then drag on any of the trend lines to fit them to the corresponding highs or lows and see if they fit. The trader should not try to force the situation; if the lines do not fit the highs and lows, then a channel has not been formed and the lines should be discarded.
This is one tool that many traders simply have no idea how to use or how it works. In every market, prices do not just keep rising and falling. Traders will always take positions and offload positions to other traders. So there will be times when the currency pairs will experience uptrends and pullbacks, as well as times of downtrends and bounces. These pullbacks and bounces reflect periods of profit taking, or when majority of traders are taking a breather. These moves are known as retracements. Retracements are a normal part of every market. What the Fibonacci tool does is to try to predict possible areas at which retracements will cease and there will be renewed buying or selling interest in the asset. The Fibonacci retracement tool is best used on the daily charts, which is the chart that correctly mirrors the true trend so that traders are not caught up in all the market noise. The trader is expected to use other technical indicators to indicate at which of the five retracement levels the price action will continue in the direction of the trend post-retracement.
Pivot Point Calculators
These are not usually found on the trading platforms of most brokers, but are customized indicators that are can be attached to the charts as software add-ons. Pivot point calculators are able to take the previous day’s price data to automatically plot the pivot points on the charts. These points can now be used as reference points of support and resistance.
Putting it All Together
Now how can you conduct graphical analysis on a currency chart and come up with the perfect trade? Let us illustrate this with a currency chart of the EURUSD.
The trend is obviously a downtrend for the EURUSD.
Identifying the trend is important, because all trade decisions a trader should make should be in the direction of the trend. So what trade decisions could a trader have made using the principles of graphical analysis we discussed above? Here are two possible trade decisions.
- The trader could have used the trend line tool to spot a clear descending triangle pattern. Since this is a bearish pattern that is in tandem with the downtrend, this is a good trade possibility.
- The trader could have used the channel tool to identify a clear descending channel, which would have identified multiple entries and exit points while in a downtrend.
Since our main focus is on trades that stick to the trend, we could have used the blue circles as entry points for shorts and the white circles as exit points.
When a trader knows how to conduct graphical analysis, it will be easy for him to identify profitable trade opportunities.