When Should I Buy or Sell a Currency Pair?

How do traders make the decision to buy or sell a currency pair?

The most popular and successful method of making decisions and analyzing FOREX markets is technical analysis. Technical analysis is used by large and small traders alike. Technical analysis ignores fundamental factors and is applied only to the price action of the market and derivative quantitative information such as volume, tick-counts, price ranges, and volatility.

Although fundamentals are the market’s ultimate prime mover, they can often provide only a long-term forecast of exchange rate movements. Technical analysis has become the tool of choice to successfully analyze and trade shorter-term price movements, as well as to set profit targets and stop-loss safeguards because of its ability to generate price-specific information and forecasts.

Technical analysis is based on the axiom that prices have some form of memory and that information is transferred from one price-time state to the next and successive states. This is easy enough to understand at an intuitive level: If a trader buys, he acts as an upward force on prices as he increases demand. If a trader sells, he acts as a downward force on prices as he increases supply. If you buy, you must later sell; if you sell, you must later buy. Thus, information on all orders in a market is in fact carried forward and the market does indeed have memory.

Historically, technical analysis in the futures markets has focused on the six price fields available during any given period of time: open, high, low, close, volume, and open interest. Since the FOREX market has no central exchange, it is difficult to estimate the latter two fields, volume and open interest. For this discussion, we will limit our analysis to the first four price fields. Derivative information from these fields is used to construct indicators. Charts show the four fields directly and are to be preferred because the information is primary rather than secondary, as with indicators. That said, both are extremely popular with traders at all levels.

Technical analysis consists primarily of a variety of technical studies, each of which can be interpreted to predict market direction or to generate buy and sell signals. Many technical studies share one common important tool: a price-time chart that emphasizes selected characteristics in the price motion of the underlying security. One great advantage of technical analysis is its visualness. A picture is worth a thousand words.