Technical analysis

All market fundamentals are depicted in the actual market data. So the actual market fundamentals and various factors, such as the differing opinions, hopes, fears, and moods of market participants, need not be studied.

History repeats itself and therefore markets move in fairly predictable, or at least quantifiable, patterns. These patterns, generated by price movement, are called signals. The goal in technical analysis is to uncover the signals given off in a current market by examining past market signals.

Prices move in trends. Technicians typically do not believe that price fluctuations are random and unpredictable. Prices can move in one of three directions, up, down or sideways. Once a trend in any of these directions is established, it usually will continue for some period.

Introduction to Technical Analysis

Technical analysis is a method of forecasting price movements by looking at purely market-generated data. Price data from a particular market is most commonly the type of information analyzed by a technician, though most will also keep a close watch on volume and open interest in futures contracts. The bottom line when utilizing any type of analytical method, technical or otherwise, is to stick to the basics, which are methodologies with a proven track record over a long period. After finding a trading system that works for you, the more esoteric fields of study can then be incorporated into your trading toolbox.

Almost every trader uses some form of technical analysis. Even the most reverent follower of market fundamentals is likely to glance at price charts before executing a trade. At their most basic level, these charts help traders determine ideal entry and exit points for a trade. They provide a visual representation of the historical price action of whatever is being studied. As such, traders can look at a chart and know if they are buying at a fair price (based on the price history of a particular market), selling at a cyclical top or perhaps throwing their capital into a choppy, sideways market. These are just a few market conditions that charts identify for a trader. Depending on their level of sophistication, charts can also help much more advanced studies of the markets.

Calculating Profit & Loss

For ease of use, most online trading platforms automatically calculate the P&L of a traders' open positions. However, it is useful to understand how this calculation is derived.

To illustrate a typical FX trade, consider the following example.

The current bid/ask price for USD/CHF is 1.6322/1.6327, meaning you can buy $1 US for 1.6327 Swiss Francs or sell $1 US for 1.6322.

Suppose you decide that the US Dollar (USD) is undervalued against the Swiss Franc (CHF). To execute this strategy, you would buy Dollars (simultaneously selling Francs), and then wait for the exchange rate to rise.

So you make the trade: purchasing US$100,000 and selling 163,270 Francs. (Remember, at 1% margin, your initial margin deposit would be $1,000.)

As you expected, USD/CHF rises to 1.6435/40. You can now sell $1 US for 1.6435 Francs or buy $1 US for 1.6440 Francs.

Since you're long dollars (and are short francs), you must now sell dollars and buy back the francs to realize any profit.

You sell US$100,000 at the current USD/CHF rate of 1.6435, and receive 164,350 CHF. Since you originally sold (paid) 163,270 CHF, your profit is 1080 CHF.

To calculate your P&L in terms of US dollars, simply divide 1080 by the current USD/CHF rate of 1.6435.

Total profit = US $657.13

Managing a Margin Account

Trading on margin can be a profitable investment strategy, but it's important that you take the time to understand the risks.

You should make sure you fully understand how your margin account works. Be sure to read the margin agreement between you and your clearing firm. Talk to your account representative if you have any questions.

The positions in your account could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold.

You may not receive a margin call before your positions are liquidated.

You should monitor your margin balance on a regular basis and utilize stop-loss orders on every open position to limit downside risk.