Forex Basics: The Importance of Charts in Forex Trading
What role do charts play in Forex trading? Are they of any value? Can a retail trader use charts exclusively for trading success?
These are just but a few of the questions we are going to answer in this post. Using charts for Forex trading is the primary analysis tool for Forex retail traders. This is simply because the fundamental analysis required for understanding global events, market moving news, interest rates, economic growth and other fundamental information is beyond most retail traders.
Even if it were possible for a retail trader to totally understand fundamental events, it would require painstaking research, analysis, and interpretation before fundamental analysis could be turned into anything useful for actual trading.
The Importance of Charts in Forex Trading
To trade using the chart, there are several key points that a trader might find it useful to understand. They are:
- Charts are based on price history. That is, charts are formed on what has already happened in the past
- Chart patterns are also based on price history
- Technical Indicators are based on past information. That is to say, the price has to move first before the indicator moves. Not the other way around
In essence, everything that you see on the chart is based on past price movement. The fundamental tenet of technical analysis in using the chart for trading is that the past can PREDICT the future. In case you didn’t see it, I emphasized the word “predict”.
The Value of Chart Trading For the Forex Trader
Charts provide past information to the trader, in the anticipation that the past can provide some clues to possible future price movement. But that is where beginning traders can take the wrong idea home. Chart trading provides clues, helps us to predict and anticipate possible future price movements, but they do not guarantee the movement of the market.
The inexperienced trader’s first encounter with Technical Analysis is akin to moving into a new realm in trading, where seemingly the Holy Grail of trading can be found when this subject of Technical Analysis is unlocked. And because of this expectation, some traders tend to trade with charts as if it were the Holy Grail. How you ask?
Some of the ways of this happening are:
- By taking unnecessary risks that are too large for their account size to handle.
- By putting their ego on the line by thinking their analysis has to always be spot on.
- By believing that charts are the primary influence on how the markets move.
People Move the Markets
People are the ones that move the markets. Traders in banks, hedge funds, central banks and other financial institutions influence the way the markets move. Sometimes, they use the charts. Sometimes, they use fundamental analysis to make their decisions.
While charts provide valuable information in how one should begin to anticipate potential price movements in the future, they are not and will never be the “Holy Grail” of trading. With a good technical analysis trading system, you can put the probabilities of success on your side, but that alone will not guarantee you success.
Other factors like your trade management, position sizing, personality, time available, understanding of how markets work, and many other elements will influence your success in trading. There are times when one might want to stay out of the markets. Times when there is huge uncertainty in the markets that could throw all your technical analysis awry.
For example, let’s say your technical analysis indicates that the market should go down. But you didn’t realize that an announcement on interest rates is coming up. Just as you place a trade towards the downside, the announcement released is a bullish one that is contrary to most expectations.
What happens then is the market participants rush in to cover their sell trades, and start going long by buying. Even though technical analysis has indicated the most likely trade is to the downside, news announcements can completely throw your trade off.
Using the Charts Correctly
When you use the chart for your trading, always remember that you could be right, and you could also be wrong. While you don’t always have to know the content and implications of news announcements, knowing WHEN these announcements are going to take place could be very helpful in your decision-making. To either stay out or to reduce the size of your trade.
Charts do provide value to trading success, but they are not the “Holy Grail” of trading. In every single case, the Holy Grail of trading that needs to be polished is right there, between your two ears and gut.
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