Forex Lesson-6. Buy or sell?
It’s time to see how to analyze the market so that you could make a trade decision – choose between a buy and sell order for a particular trade instrument.
Generally, an optimistic environment supports risk-on moves in the market (when everyone buys stocks and commodities), whereas pessimism makes investors risk-averse so that they seek safer trades to preserve their funds (and buy assets like gold and Swiss franc). However, there are various factors in play.
Remember that the market is made of people, and its behavior is a common denominator of the people’s behavior involved in it. Therefore, everything that affects people on the large scale is potentially a market driver. Below you will find a brief list of what can move the market with its respective impact on the currency.
1. Change of a country leader and highest officials (Presidential elections, Parliament elections, Central Bank’s Board and Chair). Effect: increased currency and stock market fluctuations.
Example. Japanese Nikkei 225 has surged at the end of August 2021 on the news that Prime Minister Suga is planning to step down: the market took it as a sign that reforms are coming.
2. Change of a country’s international positioning (geopolitical re-alignment of a country in the international environment, change of global priorities). Effect: increased downside pressure risk and volatility of the currency and the stock market.
Example. Here we can mention the policy of the United States regarding China. After elected President, Donald Trump has launched into the criticism of the US-China trade relations. This, in turn, led to big moves in the US dollar versus the Chinese yuan (USD/CHN).
3. Any other statewide or region wide event of high importance. Effect: increased volatility and downside risk for the currency and the stock market.
Example. The chart below shows the selloff of the British pound after the Brexit referendum results showed that Britain has voted to leave the European Union.
The logic is simple: anything that improves a country’s trade and economy is good for its currency, while tensions and quarrels with other nations usually have a negative impact on it. Stock market, in turn, likes the news about fiscal stimulus and tax cuts and is afraid of rising taxes. Finally, some actions of policymakers can influence particular sectors of an economy. For example, Joe Biden’s focus on green energy supported the stocks of the electric vehicle producers such as Tesla and Ford.
1. Change of central bank’s interest rates
Effect: rate increases lift currency, while rate cuts lead to national currency’s depreciation.
Example. The US dollar rose by 3300 points against the Japanese yen on December 14, 2016, after the US central bank, the Federal Reserve, raised its interest rate.
2. Change of central bank’s monetary policy language
Effect: hawkish statements support national currency, while dovish notes normally put pressure on it.
You will meet the words ‘dovish’ and ‘hawkish’ in economic news and articles. They refer to central bank policy. Hawkish means that a central bank is concerned about high inflation and is aiming to tighten policy and increase interest rates in an economy. Hawkish policy tends to strengthen the currency. Dovish central banks are the opposite: they seek to support the economic growth by setting interest rates at the low levels. Dovish policy is negative for the currency.
It often happens that even before changing policy (raising or cutting interest rates or doing other things) a central bank sends a signal to the market, i.e. says what its plans are. Prices of various financial instruments react to these ‘declarations of intentions’.
Example. The US dollar rose by 3300 points against the Japanese yen on December 14, 2016, after the US central bank, the Federal Reserve, raised its interest rate.
Think of it as a case of a patient and a doctor. If you’re sick, you go to a doctor because a doctor is a health professional. Therefore, if a doctor says “you’re fine”, then you’re happy and go parkouring again. If the doctor says, “sorry, mate, that’s it, you’re done”, then you’re pessimistic and unwilling to do anything risky. The same here – central banks are like economy’s health doctors. If they say it looks fine, it’s like a risk-trigger and currency booster. If they say things are bad, their currency goes down – as traders’ mood, too.
3. Change in the domestic economic environment
(GDP/unemployment/inflation/business activity/production levels/etc.) Effect: stronger domestic economic performance supports the national currency and brings risk-on moods to the stock market, while weak domestic environment infuses bearish moods into the currency and stock market.
To put it simply, the better an economy is doing, the better for its currency and vice versa.
Example. On August 6, 2021, the United States released better-than-expected labor market figures. USD/CAD rose by 700 points.
Effect: puts pressure on the currency and stock market, increases volatility.
After the victory over the US Presidency, Joe Biden was about to be inaugurated in January 2021 – and social unrests were the main new headline putting the US dollar under pressure.
Effect: natural disasters may force the currency or the stock market to plunge, while oil and gas, on the contrary, may rise in value.
Oil and gap prices are driven by demand and supply. Hurricanes hit production facilities. The less gas and oil produced and sold, the higher the prices of these energies.
With a calendar. Obviously, a natural disaster cannot be planned, you can only react to it once you hear about it, but most of the other things can. Check out the calendar!
You may find the calendar on FBS website and in the FBS Trading Broker app.
First, there’s an economic calendar for currencies. Choose the period you want to get the info: usually traders choose to see the events for the current day or week. Once the scheduled time comes, the actual reading for an economic indicator will appear in the calendar. The more it differs from the forecast, the bigger will be the impact on the currency the indicator refers to.
Notice that the events differ by importance.
- Three right dots: events of the highest importance to the market.
- Two yellow dots: events of limited importance that may not necessarily bring big moves in the market.
- One green dot: events that may go unnoticed in the market – useful for currency-specific strategies.
If you trade stocks, you’ll be interested in the calendar of companies’ earnings reports. Stocks tend to move up and down on expectations of higher/lower earnings per share (EPS). In addition, stock prices react to the actual releases.
For example, PepsiCo reported strong earnings results for the second quarter: the actual financial results were much better than analysts forecasted. As a result, the stock of PepsiCo surged! Just look at the chart below.
Most of the earnings reports come out during the so-called earnings seasons: in January, April, July, and October. During other periods, traders follow the news related to the individual companies – about the new products they have, the amounts of sales, mergers and acquisitions.
Analyzing charts may be easier if you do it in a structured way. Therefore, let’s structure the chart components right now.A chart window shows you:
- Asset’s price action.
- Indicators.
A timeframe is what you set to be the period of each piece of the price action. For example, M1 shows changes the price made each 1 minute (a green block of the chart means the price went up, while a red block signals that it went down). On D1, each step of the price corresponds to one day’s change.
There’s no one best timeframe. Everything depends on the period you plan to keep your trade open. It you will close your order after an hour, focus on H4 and H1. If you aim to keep it open for weeks, check W1 and D1.
Always check a bigger timeframe! If you trade on M30, check H1 and H4: you may notice important trends and levels there.
The first thing to look at when you open a chart is trends.
A trend is the general direction of the price of an asset on the market. There are uptrends when the price is moving to the upside and downtrends when the price is drifting down. During an uptrend, the price forms higher highs and higher lows. During a downtrend, the price forms lower highs and lower lows.
The classic trading principle is to buy in an uptrend and sell in a downtrend.
To use the full potential of trends traders draw trendlines: resistance lines connects the price’s highs, while support line goes through the price’s lows. You will need at least two points (two highs/2 lows) to draw a trendline.
For example, at the picture below we have drawn a support line through the price lows.
The purpose of this trendline is to make a projection for the future: the next time the price arrives to this line, it’s expected to rebound from it to the upside. Look like the situation unfolded:
The places marked with arrows represent good opportunities to open buy orders.
Type of chart defines what you see in the chart window:
- Line chart makes the price action take the form of a continuous edgy curve – that’s the easiest way to see it, useful for on overall understanding of price dynamics.
- Candlesticks – each step of the price looks like a candle with its body and shadows reflecting the open/close and the max/min over each period, useful for both the beginners and seasoned traders.
- Bars – similar to candlesticks but “American-style”, with the same components, used mostly by those who have specific affinity to this chart style (only in MT).
Candlestick charts are the most popular among traders because it’s possible to tell many things by looking at the size and shape of the candlesticks. For example, the so-called ‘shooting star’ candlestick (a candle with small ‘body’ and a big upper ‘wick) signals reversal to the downside if it appears after the increase in price.
To learn more about Japanese candlesticks, check the special course we have in the ‘Intermediate’ section.
There are many indicators available in MetaTrader, but most of them belong to either of the two groups:
1. Trend indicators (Moving Averages, Bollinger Bands, etc.)
These normally appear along with the price action in the chart window and serve to suggest the possible direction that price may follow. Moving Averages is the most common and used trade indicator.
2. Oscillators (MACD, Momentum, Relative Strength Index, Stochastic, etc.)
These are normally shown in a separate window beneath the main chart window and reflect internal dynamics of the market corresponding to the price action periods. Usually, traders use oscillators in combination with the price action and trend indicators to provide analytical conclusions.
Technical indicators are useful because they do all the calculations and show you the result in the visual form, thus saving your time. To use an indicator successfully, read what it shows and how to interpret its signals.
To add an indicator in MetaTrader, choose ‘Insert’ in the top panel and then ‘Indicators’.
The most common mistake of traders is making early judgments without considering the situation carefully. Yes, it’s better to focus on buy trades in an uptrend, but even in a rising trend the price doesn’t go up all the time. Moreover, what if an uptrend reverses? To open any trade, you need to find several signals on the chart that point in one direction, buy or sell. Trend is only one of such signals.
It’s always important to see the bigger picture. If you think about buying, check if there are any obstacles above the price. After zooming out, we can see that the pair came to the area of previous highs at 1.1900, from which it reversed down. As a result, a good trade idea would be to wait for the price to form a lower high after failing to break through this line and then sell.
Pay attention to resistance and support levels. Resistance is the level above the current price where its growth will likely stop/reverse. Resistance can be provided by the previous highs/lows, Moving Averages, important levels like $2000 for gold and others. The same things can stop/reverse the decline of the price – in this case, it will be support levels.
Have a look at the chart below.
We have market the reasons why there was sense to open a sell trade with numbers 1, 2, and 3. What do we mean here? First, AUD/USD formed a lower high – a sign that the uptrend paused. Second, the price broke below the 20SMA (Moving Average, a violet line). Third, the RSI indicator went below the key level of 70. These three reasons may give a trader enough confidence for a sell order. In addition, there was actually a fundamental driver: the Reserve Bank of Australia extended its bond-buying program to at least mid-February. This led the Aussie down. In other words, technical reasons aligned with economic ones giving the trader a good opportunity.
Notice that Take Profit was set at the previous low, while the Stop Loss was above the breakout level.
Lesson summary
- Various political, economic, natural, and social events move currencies, energies, metals, stocks, and indices.
- Events like hurricanes take the market by surprise, but other events like the release of a country’s inflation data are listed in the economic calendar. You can check the calendar every day before you start trading.
- Policy of central banks has the biggest impact on financial assets, so it’s worth monitoring the bank’s policy, decisions, and statements.
- While analyzing charts, look at the price itself (Japanese candlesticks). Technical indicators can also help in your analysis.
Thank you for going through our lessons for beginners. Now you know the basics! Manage your funds wisely and plan your trades with care. Keep practicing: only practice will allow you to gain trading experience and skills. Attend live trading and education by FBS. The company’s analysts and trading tutors are always there for you to answer your questions. Check other courses for more trading insights!
No comments