How to analyze the charts

Chart analysis is the very foundation of successful trading in financial markets. In today's review, we are going to discuss how to analyze charts of financial instruments, draw relevant conclusions and make forecasts regarding further price movement.

Ways to Analyze the Charts

There are several techniques used to analyze the graphic behavior of the price.

Technical analysis: identification of trends, support and resistance levels, reversal and continuation patterns;
Indicator analysis: reading and understanding the signals of the trend indicators and oscillators;
Candlestick analysis: finding candlesticks of various shapes and candlestick patterns based on which we can make conclusions about the further behavior of the price.

Each of these methods allows performing forex chart analysis. However, in order to make an informed trading decision based on the given information, the traders need to use a specific trading strategy. It can be based on one of the listed methods or combination thereof.

How to analyze forex charts

How to Analyze the Chart the Right Way: Rules

The fundamental goal of the chart analysis is to identify where the price is going to move next. From a practical standpoint, to analyze the charts correctly, you need to understand when and what type of trade to open, and when to exit it.

To improve trading literacy, you will need to familiarize yourself with various types of analysis, even though you will chiefly use those which form the backbone of your trading strategy. You can create it yourself or use a ready-made one.

So, a key principle of chart analysis is to learn the ins and outs of the methods that will be used with your trading strategy.

The second principle is the confirmation of the trading signal. It’s best if the trading strategy includes two or three analytical methods. These can be a technical analysis and trend indicators, or technical analysis and candlestick patterns, or a combination of trend indicators and oscillators.

Chart Analysis: Hands-On Example

Let’s take a look at the chart analysis as exemplified by EUR/USD pair. We shall use a combination of technical and candlestick analysis for this.

Key tools: horizontal technical levels, ascending, descending and sideways channels.

Auxiliary tools: technical analysis patterns (head and shoulder, pennant, triangle, double and triple bottom, double and triple top). Additionally, you can use candlestick patterns on higher time frames (doji, absorption, etc.)

You should also know how to choose the right time frame for the analysis. If you are using a ready-made trading strategy, it typically indicates the relevant time frame. In our case, we shall use a comprehensive technical analysis, starting with the highest time frame (monthly one) and gradually moving to the one we will be trading with (hourly time frame). Why so?

1. The basic rule of timeframe analysis is this: the higher the time frame on which the level formed and worked out, the stronger it is.

2. The patterns of the technical analysis on higher time frames signal a longer reversal or trend continuation.

3. Candlestick patterns on monthly and daily charts also provide strong signals.

Before we get started, we need to pick the chart for the analysis. The most common and insightful one is the candlestick display of the price which we will be working with.

Checklist Exemplified by EUR/USD Analysis

To demonstrate how to analyze the charts using the aforementioned methods, we will use an example of the EUR/USD pair.

1. Open a monthly chart of EUR/USD and mark strong technical levels and trends:

Using the dark gray color, we shall indicate the descending channel 1.6038 –1.3992–1.2330 as of July 1, 2008 (the prices of the base points of the channel construction — two highs and a minimum value between them).

Next, using bold red lines, we shall mark strong horizontal levels. From a practical standpoint, the important ones are those that are the closest to the current price value. The dark red circles in the picture demonstrate points where the levels closest to the price are built and worked out.

Based on data available on the monthly chart, we can say that it won’t be easy for the price to travel to the 1.1932 level from the bottom upwards since this is where the two strong resistance levels (horizontal and upper boundary of the descending trend) intersect..

2. Now let’s move to the weekly time frame and find additional graphic elements for the analysis. Using dark blue horizontal lines, we shall mark two additional levels — 1.1717 and 1.2100 — which are closest to the current price.

3. Let’s take a look at the technical picture in the daily chart. We can clearly see the sideways trend between strong monthly levels 1.1603–1.1732 with interim daily level 1.1717. By the way, when the price bounces off the resistance, we can see reversal candlestick patterns of bearish absorption. At the time when they formed, there was a strong (double) reversal signal i.e., bounce off the resistance level downwards confirmed by the candlestick pattern.

4. These are the conclusions we can draw based on this:

In the sideways trend, when the price bounces off the support line upwards, we can open a long position. If the price bounces off the resistance downwards, we can open a short position. Now the price is bouncing off the resistance downwards, which means that it’s likely to go down. The closest target is the 1.1717 interim level, and 1.1603 in case of its breakout.
You could have opened the short position right then, placing the stop loss behind 1.1932, and setting take profit slightly above the support 1.1603. It would have been the medium-term position for those who prefer this trading style.
Since we are working with Н1 time frame, we shall continue analyzing the chart further and examine an example with small trades.

5. After that, we are looking for additional levels on the 4H and 1H time frames. Using a dashed line, we are going to mark local interim levels.

Here’s what we see here:

Local uptrend within the sideways trend 1.1603–1.1932 ended in the Double Top reversal pattern. This is another confirmation that the price is going to decline.
The downward movement in the 1.1603–1.1932 corridor can involve rollbacks, and we can take profit partially.
The quotes are moving closer to the support line of the local corridor 1.1809–1.1849 (which is marked with the dashed line). When the price bounces off it upwards, we open a long position with a target at the resistance level. If the price breaks out the lower boundary and consolidates under it, we go short with a target near the place where the grey trend begins.

It is just one of the examples illustrating the chart analysis. All traders should have such a checklist customized for the strategies they are using to trade in financial markets.