Forex In A Nutshell

Introduction into Exchange

This section provides brief information on the exchange. In this section you will study:

• What the exchange is;
• Major features of the exchange;
• Basic notions and terms related to the exchange trade.

The section is divided into two subsections.

The subsection 1 contains general information which will be useful for further understanding of the main subject of our tutorial. That is why it is strongly recommended to everyone who is not familiar with what the exchange is and how it works.

The subsection 2 contains additional information and is recommended to those who want to have a deeper grasp of the subject.

General Information

Exchange

An exchange is a marketplace with established rules where people come to trade, that is to buy or to sell something. For example, on the exchange you can buy or sell goods, securities, foreign currencies, etc.

Participants

People who come to the exchange to buy or to sell something are called traders. Traders buy something from or sell something to dealers who work on the exchange. Further in this tutorial you will often read about two operations:

• Buy the trader buys, the dealer sells;
• Sell the trader sells, the dealer buys.

As you see, both traders and dealers can buy and sell. Note that when we talk about Buy and Sell operations, we talk about them from the point of view of the trader.

Pricing

Anything you buy or sell has its price. Prices on exchanges are formed on the basis of the supply and demand. If more traders want to buy something (demand) than sell it (supply), then the price moves up. Conversely, if more traders want to sell something (supply) than buy it (demand), then the price moves down. So, the price is said to be floating.

Speculation

Floating prices provide a good opportunity for speculation on exchanges. The idea of speculation is to buy something, hold it for some time and then resell it at a higher price in order to gain profit. For example, you buy 100 ounces of gold for $500 per each:

100 x 500 = $50,000

In a while the price of gold increases by $50 per ounce. You sell the previously purchased gold for $550 per ounce:

100 x 550 = $55,000

As a result, you gain:

55,000 - 50,000 = $5,000

But trading on the exchange is not all rose-colored, it does involve certain risks. Suppose, you buy a product hoping that its price will move up in future, but it turns out that the price goes down. As a result, you have to sell the product at a lower price and suffer loss. Note that speculation always involves two operations: buying something and then selling it.

Types of Exchanges

Depending on the product being traded, exchanges can be divided into the following types:

• Commodity exchanges which facilitate the trading of physical goods and products. Among the principal US commodity exchanges are: the New York Board of Trade (NYBOT) which is a global market for trading sugar, cotton, coffee and cocoa; the Chicago Board of Trade (CBOT) which is a leader in trading of a variety of agricultural products.
• Stock exchanges which facilitate the trading of securities. Among the principal US stock exchanges are: the New York Stock Exchange (NYSE), the National Association of Security Dealers (NASDAQ) and the American Stock Exchange (AMEX).
• Foreign exchanges which facilitate the trading of currencies.

Risk Reducing

You already know that speculation can bring some amount of risk to traders who fail to forecast price movements. To be a successful trader, you should be able to analyze and assess the situation in the market. This will help you to correctly predict the market behavior, in other words, price movements. There are two basic approaches to analyzing the situation in the market:

• Fundamental analysis;
• Technical analysis.

The fundamental analysis concentrates on the underlying causes of price movements, while the technical analysis studies the price movements themselves. Volumes of books have been written about both of these approaches. We will just scratch the surface and consider the essential difference between them.

Fundamental Analysis

Prices constantly change because they are affected by an overwhelming variety of conditions and factors, such as economic, political, social, etc. These factor and conditions are what the fundamental analysis focuses on. To predict price movements, fundamentalists have to:

• Reveal the factors that influence a particular market;
• Reveal the way these factors influence the market;
• Predict the price movement by interpreting a wide variety of economic information, news, government-issued reports, etc.

Technical Analysis

As opposed to fundamentalists, technicians hold that all current market information is already reflected in the market price. Therefore, a study of price action is all that is required. Technicians use the history of prices to predict future prices.

The most basic concept of technical analysis is that prices have a tendency to trend. There are three types of price trends:

• Uptrend - The price moves up;

• Downtrend - The price moves down;

• Sideways trend -The price moves around the average value (there is no a strongly pronounced uptrend or downtrend).

The traders' golden rule says: "The trend is your friend". By this they mean that the best trading strategy is to follow the trend. If the price is trending:

• Up - Use the buying strategy;
• Down - Use the selling strategy;
• Sideways - Stay out of the market.

The primary tools of technical analysis are charts. Charts are a graphical presentation of the price movement. They show the change of the price within a certain time period, e.g. month, week, day, 1 hour, 30 minutes, etc.

In addition to charts, technicians use hundreds of indicators that help to identify better trading opportunities.

For additional details about technical analysis please see Forex_In_A_Nutshell#Appendix:_Techincal_Analsys

Fundamental vs. Technical

Fundamentalists and technicians have been at odds with one another for a long time. There is no a clear answer as to which approach is better. The general assumption is that fundamental analysis requires much time and effort and, therefore, is better for long-term traders. Short-term traders are usually recommended to use technical analysis. It is less time-consuming and allows to follow many markets. However, most traders agree that it is more effective to use technical analysis in combination with the fundamental one. By knowing the tactics and techniques of both approaches, you will be better suited to make your own trading decisions.

Forex

Now that you have got the general idea of what the exchange trade is, it's high time we moved to the main subject and discuss everything which concerns trading on Forex.

This article describes the traditional procedure of Forex trading introducing the most basic terms and notions related to the subject.

Terms

Forex

Maybe you have traveled to Canada and exchanged your American dollars for Canadian dollars. Or, perhaps, you have traveled from England to Japan and exchanged your English pounds for yens. If so, you have actually experienced what happens on Forex. Forex (Foreign exchange) is an exchange where different currencies (money) are traded.

Currency

There are domestic currency and foreign currencies on Forex. The domestic currency is the currency for which you buy and sell foreign currencies. To understand the difference better, compare Forex with a commodity exchange. On the commodity exchange you buy and sell products for money. On Forex it is the same. You buy and sell foreign currencies (as though products) for a domestic currency (money). Domestic currencies are country-dependent. In US you buy and sell foreign currencies for American dollars, in Japan for Japanese yens, in Great Britain for British pounds, etc.

Currency Pair

When you buy or sell currencies, you actually exchange one currency for another. The two currencies form a currency pair, for example, USD/JPY. The first currency in a currency pair is called a base currency. The second one is called a counter currency.

On Forex you will always find records like this:

USD/JPY = 120.05

Where:

USD the base currency;

JPY the counter currency;

120.05 the price of the base currency as measured against the counter currency.

You should read this record as follows: 1 American dollar costs 120.05 of Japanese yens.

Lot

Lot is a unit to measure the amount of the trade. The value of the trade always corresponds to an integer number of lots.

Bid/Ask

Depending on the operation (Buy or Sell) you want to perform on Forex, you are quoted either an ask price or a bid price.

Ask price is the price at which you can buy a currency from a dealer. For example, if USD/JPY has an ask price of ¥120.15, it means that you can buy 1 American dollar for 120.15 of Japanese yens.

Bid price is the price at which you can sell a currency to a dealer. For example, if USD/JPY has a bid price of ¥120.05, it means that you can sell 1 American dollar for 120.05 of Japanese yens.

The bid and ask prices make up the rate of the pair and are usually recorded like this:

USD/JPY = 120.05/120.15

or

USD/JPY = 120.05/15

The difference between the ask price and the bid price makes it possible for Forex to be profitable. That is why the ask price is always higher than the bid price.

Spread

The difference between the ask price and the bid price is called the spread. For example, if USD/JPY has an ask price of ¥120.15 and a bid price of ¥120.05, the spread is ¥0.10.

Note that each currency pair has its own spread which is usually fixed. It means that if an ask price of USD/JPY changes from ¥120.15 to ¥120.20, a bid price will accordingly change from ¥120.05 to ¥120.10. Spreads are measured in pips.

Pip (Point)

Pip is the smallest possible change of the price. All currency pairs are priced to a fixed precision. There are currency pairs which are priced to two digits after the decimal point. For example, USD/JPY = 120.05. The smallest change of such currency pairs will always be 0.01 (1 pip = 0.01). So if the price of USD/JPY changes from 120.05 to 120.08, the pair is said to make a 3-pip change.

However, most currency pairs are priced to four digits after the decimal point. For example, EUR/USD = 1.2066. The smallest change of such currency pairs will always be 0.0001 (1 pip = 0.0001). So if the price of EUR/USD changes from 1.2066 to 1.2076, the pair is said to make a 10-pip change.

Speculation on Forex

The goal of any Forex trader is to make profit. "Buy low, sell high" is what the traders' primary rule says. To benefit on Forex, you should do one of the following:

• Buy a currency at a lower price and then sell it at a higher price;
• Sell a currency at a higher price and then buy it at a lower price.

As you see, in both cases you necessarily perform two opposite operations. Together these operations form a position.

When you perform the first operation (either buy or sell), you open a position. If you buy a currency, you open a buy position (traditionally referred to as a long position). If you sell a currency, you open a sell position (traditionally referred to as a short position).

When you perform the second operation (opposite to the first one), you close the position and enjoy your profit. Note that you can get profit only after closing the position.

A position can be closed:

• Completely - you sell/buy the whole amount of the currency previously purchased/sold;

• Partially - you sell/buy a part of the amount of the currency previously purchased/sold.

A position can be closed on the same day it is opened. Or, it can be held open past the end of trading day. In this case the position will be rolled forward to the next trading day. This process is known as a rollover. The trading day hours are specific to each foreign exchange. For instance, New York foreign exchange opens at 8:00 am and closes at 5:00 pm EST (GMT -5). It doesn't work on Saturdays and Sundays. Let us now consider some examples to show how speculation on Forex can be performed.

EUR/USD price movement

Suppose you believe that EUR/USD will increase in its price. You've got enough American dollars to purchase €100,000 at $1.1230 per Euro.

You:

• Make an order to your dealer to open a buy position at point A;
• Pay €100,000 x $1.1230 = $112,300 to receive €100,000.

Your predictions about the EUR/USD price change have turned to be correct. The price of the pair moves up and when it reaches $1.1270, you decide to sell the previously purchased Euros. You:

• Make an order to your dealer to close the position at point B;
• Receive €100,000 x $1.1270 = $112,700;
• Make a clear profit of $112,700 - $112,300 = $400.

Trading on Forex can create massive amounts of wealth, but it is not without risks. Let us consider another example.

EUR/USD price movement

Again, suppose you think that EUR/USD will increase in its price. You've got enough American dollars to purchase €100,000 at $1.1270 per Euro.

You:

• Make an order to your dealer to open a buy position at point A;
• Pay €100,000 x $1.1270 = $112,700 to receive €100,000.

Indeed, for some time the price of EUR/USD moves up, reaches point B, you keep on waiting for further increase. But suddenly the trend changes and the price starts to move down. You still wait for some time hoping that the situation will improve. However, when EUR/USD falls to $1.1260, you decide to sell the Euros to prevent further losses.

You:

• Make an order to your dealer to close the position at point C;
• Receive €100,000 x $1.1260 = $112,600;
• Say farewell to $112,700 - $112,600 = $100.

The best solution in this case would be, of course, to close the position at point B (or at least somewhere between A and B) since after that the trend has changed. However, it has been quite reasonable to sell the Euros shortly after the change of the trend. Note that the price has fallen by 20 pips for less than 20 minutes. So, if you had not closed the position at point C, you would have suffered much greater losses.

Orders

Each time you want to open or close a position, you make an order to your dealer. There are different types of orders you can make. Let us consider each of them in detail.

• You can order your dealer to open a position (to buy or to sell a currency) at the current price. Such order is called a market order.
• You can order your dealer to close a position at the current price. Such order is called a close order.
• You can order your dealer to open a position when a particular price is reached. Such order is called an entry order. For example, the current price of EUR/USD is $1.1200. But you want to open a position when the price is $1.1230. In this case you can make an entry order and a dealer will open the position when the price reaches the level you have specified.
• You can make a limit order. This is an order to close a position when a particular price is reached. The limit order is used to lock in the profit. For example, you have opened a position on EUR/USD at $1.1200. You believe that the price will be changing in your favor. But you want your position to be closed at $1.1230 despite further changes. In this case you can make a limit order and a dealer will close your position when the price reaches the level you have specified. Note that for one position there can be only one limit order.
• You can make a stop order. This is also an order to close a position when a particular price is reached. But unlike the limit order, the stop order is used to prevent further losses. For example, you have opened a position on EUR/USD at $1.1200. Certainly, you expect the price to be changing in your favor. But in case the price moves down, you want your position to be closed at $1.1190. So you can make a stop order and a dealer will close your position when the price falls to the level you have specified. Note that for one position there can be only one stop order.

Speculation on Margin

Why Do You Need Margin?

Imagine you have come to Forex with a million of American dollars. You strongly believe that the currency pair EUR/USD will skyrocket in a month, you spend your million to purchase Euros at $1.2904 per each. So you receive:

$1,000,000 / $1.2904 = €774,953.50

In a month EUR/USD reaches $1.3224. You sell the previously purchased Euros and get:

€774,953.50 x $1.3224 = $1,024,798.51

Thus, your clear profit is:

$1,024,798.51 - $1,000,000 = $24,798.51

The sum is quite impressive, isn't it? But what about people who cannot afford trading on millions? If you calculated the profits that could be made on $10,000 in a month period, you would realize that they are really not worth all efforts. So what if you are not a millionaire, but also cherish the hope of making a fortune? A wonderful opportunity for you would be trading on margin.

It's Like Gamble

Trading on margin can be compared with a gamble. The idea of this gamble is that in case you don't have enough money to buy a certain amount of currency, the dealer lends you the deficient amount. By selling the purchased currency you don't have to share the profit with the dealer, but you are to return the money that the dealer has lent you. As the dealer lends you the money, he/she has the right to set a number of rules. These rules are not numerous and quite simple. Let us take a look at them.

Rule 1: When you purchase a currency, a dealer shall lend you $99 per each dollar you invest in trading.

Rule 2: After you sell the purchased currency:

• The dealer shall pay you back the money that you have spent on buying the currency.
• The dealer shall take back the money that he/she has lent you to buy the currency.

Rule 3: In case the trade is successful, the dealer shall give all the profit to you.

Rule 4: In case the trade is unsuccessful, you shall cover all losses.

Note that when trading on margin, you have to perform both operations (buying and then selling) within the same exchange because the major part of the money you use for trading belongs to the dealer.

"Gamble" in Practice

Let us now consider the two possible scenarios of the gamble we have described. The following information will be common for both examples:

Your money	$1,000
Dealer's money	$99,000
Total	$100,000
EUR/USD ask price	$1.2904

Scenario 1

Together with the dealer you buy Euros at $1.2904 per each, thus acquiring:

$100,000 / $1.2904 = €77,495.35

In a month EUR/USD mounts to $1.3224. You sell the Euros and get:

€77,495.35 x $1.3224 = $102,479.85

Following the rules of the gamble the dealer:

• Returns your $1,000;
• Takes back his/her $99,000;
• Gives you all the profit, that is $102,479.85 - $100,000 = $2,479.85

As you see, the gamble has been worth of candle and yielded a reasonably good profit.

Scenario 2

Again, together with the dealer you buy Euros at $1.2904 per each and get: $100,000 / $1.2904 = €77,495.35

But in a month EUR/USD falls to $1.2584. You sell the Euros and receive:

€77,495.35 x $1.2584 = $97,520.15

Following the rules of the gamble, the dealer returns you $1,000 and is eager to get back his money, but here is the problem. The sum received after the selling of Euros is obviously not enough to pay back the dealer's $99,000. Let us remind that according to the rules, it is you who cover all losses. So, in the present situation you will have to pay $100,000 - $97,520.15 = $2,479.85 to the dealer.

Evidently, the dealer cannot rely upon your honesty and be absolutely sure that you will cover all his/her losses. That’s why, before you start trading, the dealer will charge you an extra sum of money for the purpose of covering possible losses. As soon as this extra money becomes equal to the potential losses, the dealer:

• Sells the currency you have purchased;
• Returns you the money you have spent on buying the currency;
• Takes the extra sum of money you have provided to cover his/her losses.

Trading on Margin in Forex Terms

Leverage

Let us remind that when trading on margin you use your own money plus the money borrowed from a dealer. The ratio of your money to the dealer's money is called leverage. The leverage varies depending on the exchange and can also vary within one exchange. For example, if the leverage is set to 100:1, it means that you invest $1 per each $99 borrowed from a dealer, so $1 out of $100 belongs to you, the other $99 belong to the dealer. The leverage is a very important tool, because it increases your buying power: with the ratio of 100:1 you will have to invest only $1,000 to trade as though you've got $100,000.

Account

You don't have to go to the dealer and give him/her money each time you want to open a position. Instead, you get an account where you deposit all the money you are ready to invest in trading. With this sum you can open several positions on different currency pairs at one time.

Balance and Equity

The amount of money you deposit in your account is called a balance. The balance changes only after you close a position or a number of positions. If the trade results in profit, your balance increases. If you incur losses, your balance goes down. There is also an equity balance (equity). Plain and simple, this is your potential balance. It equals your balance plus the current profit or loss. As soon as you close all positions, the equity becomes your real balance.

Used Margin

The amount of money you invest in the current position(s) is called a used margin. Now remember the rules of the gamble: the used margin is the sum that the dealer shall pay you back after the position is closed.

Usable Margin

The amount of money equivalent to your equity minus used margin is called a usable margin. With this money you can maintain open positions, because the potential profit on one position may cover losses on another one. You can also use this money to open new positions.

Margin Call

In case the usable margin falls to zero, all your positions are immediately liquidated. This process is known as a margin call. To prevent the margin call, you may use partial closing of your lossmaking positions.

Examples

Let us now consider some examples to illustrate how trading on margin is carried out. Take a look at the following table.

Though it seems quite complicated, there is really nothing dreadful in it. We have tried to provide most detailed explanations to make it easier for you to follow the point. Imagine that you have got $1,000 which you deposit in your account.

After that you decide to purchase €70,000 at $1.2045 per Euro. You open a Buy position and together with the dealer spend:

Ask Price x Amount

$1.2045 x €70,000 = $84,315.

You trade with 100:1 leverage, so after the position is closed, the dealer must pay you back the used margin which is equal to:

Spent / 100

$84,315 / 100 = $843.15.

Consequently, the amount that must be returned to the dealer is equivalent to:

Spent - Used Margin

$84,315 - $843.15 = $83,471.85.

If you sold the Euros straight away, you would receive:

Bid Price x Amount

$1.2040 x €70,000 = $84,280.

Note that the "Current Price" column lists the cost of €70,000 at the current moment. With the current price of $84,280 your profit/loss is:

Current Price - Spent

$84,280 - $84,315 = -35.

It means that in case you close a position, you will lose $35. With the current profit/loss of -35, your equity (a potential balance) is equivalent to:

Balance + P/L

$1,000 - $35 = $965.

The usable margin at this point is:

Equity - Used margin

$965 - $843.15 = $121.85.

Each time the rate of the currency pair changes, the current price, profit/loss, equity and usable margin are recalculated as described above.

As you can see from the table, the EUR/USD rate is gradually growing. Your losses decrease and, presently, turn into profit. You decide to close the position when the bid price mounts to $1.2049. At this point the equity is equal to $1,028. As soon as you close the position, the equity becomes your real balance with the profit of $1,028 - $1,000 = $28.

Let us now show the situation when the predictions fail and the rate goes down. Take a look at the following table.

Suppose everything has started as in the first example. You have deposited $1,000 in your account, purchased €70,000 at $1.2045 per each and started waiting till the rate goes up. However, your predictions have turned to be incorrect - the rate is rapidly moving down. When the bid price falls to $1.2023, the current price of €70,000 is:

$1.2023 x €70,000 = $84,161.00.

The profit/loss now makes up:

$84,161 - $84,315 = -154.

The equity has nearly fallen to the used margin level:

$1,000 - $154 = $846.

Consequently, the usable margin is close to zero:

$846 - $843.15 = $2.85

Unfortunately for you, this is the point when the dreaded margin call happens. Should you have more than one position, you could have a chance to cover the losses on this position. However, at the present situation your position will be immediately liquidated, whether you want it or not. As a result, you will incur losses of $1,000 - $846 = $154.

Extra Charges

Hitherto we have been speaking about trading on margin omitting some extra charges and fees you may be required to pay to the dealer. They are commissions, interest on a loan and rollover interest. Let us take a closer look at each of them.

Commission

A commission is a fee paid to the dealer for arranging the purchase or the sale of a currency, that is for opening or closing of a position. The commission can be charged:

• For opening of a position;
• For closing of a position;
• For both opening and closing of a position.

Commission can be fixed. In this case it is typically expressed in pips. Or, it can be charged depending on the amount of the currency being traded. In this case it is expressed as a percentage. Note that on some foreign exchanges you may not be required to pay commission.

Interest on a Loan

Interest is a fee charged for the use of the money borrowed from a dealer. The interest rate is expressed as a percentage and can depend on the currency being borrowed, the amount of currency as well as the time period you borrow the money for.

Note that on some foreign exchanges you may not be required to pay interest.

Rollover Interest

If you hold your position(s) open past the end of trading day, you will either pay or earn rollover interest. This is the difference between the interest rates of the two currencies being traded. If you purchase a currency with a higher interest rate than the one you have borrowed from a dealer, you will earn the difference between the interest rates.

If you purchase a currency with a lower interest rate than the one you have borrowed from a dealer, you will have to pay the difference between the interest rates.

The interest rates of currencies constantly change. So one day a rollover may result in interest rate being added to your account, another day it may result in interest rate being subtracted from your account. Note that some foreign exchanges do not maintain the rollover interest policy.

Appendix: Techincal Analsys

Charts

Charts are a graphical presentation of price movements. They are made in two coordinates - price and time. The price is typically shown on the vertical axis and date (time) on the horizontal axis. Price movements can be charted on a monthly, weekly, daily, or intra-day basis.

There are different types of charts. The three most popular are:

• Bar chart;
• Candlestick chart;
• Line chart.

Bar Chart

A bar chart consists of a series of bars, each bar representing one time period: month, week, day, 1 hour, 30 minutes, etc. A bar looks as follows:

As illustrated on the top, the bar shows the four values:

• The horizontal line on the left indicates an opening price. The opening price is the price that existed at the beginning of the period.
• The top of the bar indicates the highest price that has been reached during the period.
• The bottom of the bar indicates the lowest price that has been reached during the period.
• The horizontal line on the right indicates a closing price. The closing price is the price that existed at the end of the period.

Note that bar charts are also called OHLC charts, because they indicate the Open, High, Low, and Close price of a period.

The chart below is an example of a monthly bar chart for the EUR/USD currency pair.

Candlestick Chart

Candlestick charts have been around for hundreds of years. They are often referred to as "Japanese candles" because the Japanese would use them to analyze the price of rice contracts. A candlestick chart consists of a series of candles, each candlestick representing one time period. A candlestick looks as follows:

Similar to bar charts, candlestick charts also display the Open, High, Low, and Close price of a certain period. The difference is the use of color to show if the price went up or down over the period. Note that there are no specific colors for growing and falling candles. Normally, an empty candle (in our example the white one) means that the price has been growing during the period and a filled candle (in our example the red one) means that the price has been falling during the period.

The interpretation of candlestick charts is based primarily on patterns. The patterns are classified as uptrend, downtrend, trend reversal and neutral patterns. Below are a few of the popular ones and what they mean:

Long empty candlesticks are an uptrend pattern. They show strong buying pressure. The period opened near its low and closed near its high. This indicates that prices advanced significantly from open to close and buyers were aggressive.

Long filled candlesticks are a downtrend pattern. They show strong selling pressure. The period opened near its high and closed near its low. This indicates that prices declined significantly from the open and sellers were aggressive.

The hammer and the hanging man are reversal patterns. The hammer is a reversal pattern that appears after a price decline. It signals an uptrend revival. The hanging man is a reversal pattern that appears after a price growth. It signals a downtrend revival.

This pattern is known as a "star". It is a neutral pattern. It indicates that the open and close are equal. Neither buyers nor sellers were able to gain control and a turning point could be developing.

The chart below is an example of a monthly candlestick chart for the EUR/USD currency pair.

Line Chart

Line charts are the most simple. They tell less than bar charts and candlestick charts, but give a clearer picture. A line chart consists of a single line which normally represents the closing price of each period. The chart below is an example of a monthly line chart for the EUR/USD currency pair.

Technical Analysis Indicators

Technicians use hundreds of different indicators that are added to charts to predict price movement. In this appendix you will examine the most popular of them, they are: support and resistance levels and moving average.

Support and Resistance Levels

Prices do not move in a straight line in any direction. They move in a zigzag manner. These zigzags resemble a series of successive highs and lows. It is the direction of those highs and lows that constitutes a trend.

An uptrend is identified by a series of successively higher highs and lows. For an uptrend to continue, each successive low must be higher than the one preceding it. Each high must be higher than the one before it.

A downtrend is identified by a series of successively lower highs and lows. For an downtrend to continue, each successive low must be lower than the one preceding it. Each high must be lower than the one before it.

A sideways trend is identified by a series of successively horizontal highs and lows. For an sideways trend to continue, the highs and lows must be on the same level.

To determine the direction of the trend as well as the future price movements, technicians draw trend lines.

When prices trend between two parallel trend lines, they form a channel. The top trend line is called a resistance line. The support is a price level where technicians find that it is difficult for market prices to penetrate lower.

The bottom trend line is called a support line. The resistance is the opposite of support and represents a price level where selling interest overcomes buying interest and advancing prices are turning back. Support and resistance do not only display the strength and weakness of the price, but also act as buy and sell indicators. When prices hit the support trend line, this may be used as a buying area and when prices hit the resistance line, this may be used as a selling area.

In case the price breaks through the support line, it is a signal that the trend is changing.

Moving Average

The moving average is one of the easiest indicators to understand. It shows the average price of a product over a period of time. The most popular type of moving averages is the simple moving average (SMA). A simple moving average is formed by calculating the average price over a specified number of periods. While it is possible to create moving averages from the open, high, and low prices, most moving averages are created using the closing price. For example, a 5-day simple moving average is calculated by adding the closing prices for the last 5 days and dividing the total by 5.

10 + 11 + 12 + 13 + 14 = 60

60 / 5 = 12

The calculation is repeated for each day on the chart. The averages are then joined to form a smooth curving line - the moving average line. Continuing our example, if the next closing price in the average is 15, then this new day would be added and the oldest day, which is 10, would be dropped. The new 5-day simple moving average would be calculated as follows:

11 + 12 + 13 + 14 +15 = 65

65 / 5 = 13

Thus, over the last 2 days, the SMA moved from 12 to 13. As new days are added, the old periods will be subtracted and the moving average will continue to move over time. Take a look at the example of the simple moving average.

All moving averages are lagging indicators and will always be "behind" the price. As you can see on the picture, when the price of EUR/USD is trending down, the simple moving average remains above the price. This indicates a strong selling pressure. When the price is trending up, the simple moving average remains below. This indicates a strong buying pressure. As moving averages are considered to be lagging indicators, they fit in the category of trend following indicators. When prices are trending, moving averages work well. However, when prices are not trending, moving averages can give misleading signals.

One of the most common buy or sell signals is the moving average crossovers. These occur when two or more moving averages are added. Take a look at the following chart.

When a short-term moving average (in our example MVA (10)) crosses below a long-term one (in our example, MVA (20)), it's high time to sell. Conversely, when a short-term moving average crosses above the long-term, it's high time to buy.

For extra insurance you can use a triple crossover, whereby the shortest moving average should pass through the two longer ones. This is considered to be an even stronger indicator. In order to reduce the lag in simple moving averages, technicians often use exponential moving averages (EMA). EMA reduces the lag by applying more weight to recent prices relative to older prices. The weighting applied to the most recent price depends on the specified period of the moving average. The shorter the EMA's period, the more weight will be applied to the most recent price. For example: a 10-period exponential moving average weighs the most recent price 18.18% while a 20-period EMA weighs the most recent price 9.52%. The calculating an EMA is much harder than calculating an SMA. The important thing to remember is that the exponential moving average puts more weight on recent prices. As such, it will react quicker to recent price changes than a simple moving average.