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TECHNICAL ANALYSIS

FOREIGN EXCHANGE MARKETS

GROUP 6 I TRIMESTER IVINTERNATIONAL FINANCE
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TABLE OF CONTENTS:

Section 1: Introduction: Foreign Exchange Market Overview ......................................................... 5

Section 2: Technical Analysis in Forex Markets .............................................................................. 6

Section 3: Basic Technical Analysis Patterns .................................................................................. 9

Section 4: Technical Analysis: Charting Techniques ..................................................................... 13

Section 4.1:Cycle based indicators .......................................................................................... 13

Section 4.1.1: Elliot Wave theory ......................................................................................... 13

Section 4.2:Momentum Indicators .......................................................................................... 17

Section 4.2.1:MACD: Moving Average Convergence Divergence ........................................... 18

Section 4.2.2:RSI: Relative Strength Index ........................................................................... 19

Section 4.3:Trend approach to technical analysis..................................................................... 21

Section 4.3.1: Moving Averages .......................................................................................... 21

Section 4.4: Chart Based Indicators ......................................................................................... 23

Section 4.4.1: Candlestick Charts ......................................................................................... 23

Section 5: Practical Application to Current trends in the Foreign Exchange Market ...................... 28

Section 5.1:Cycle Based .......................................................................................................... 28

Section 5.1.1: Elliot wave .................................................................................................... 28

Section 5.2: Momentum Based ............................................................................................... 29

Section 5.2.1:Relative Strength Index ...................................................................................... 29

Section5.2.2: Moving Average Convergence/Divergence ......................................................... 30

Section 5.3: Trend Based ........................................................................................................ 31

Section 5.3.1: Moving averages ........................................................................................... 31

Section 5.4: Chart Based ......................................................................................................... 36

Section 5.4.1: Candlesticks .................................................................................................. 36Section 6: Technical Analysis: Advantages & Disadvantages ........................................................ 38

Section 7: How traders and dealers use Technical Analysis? ........................................................ 39

Section 8: Bibliography ............................................................................................................... 40
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List of Graphs and Figures

Figure 1: Technical analysis is based on the premise that markets trend and that those trends tend to

persist...................................................................................................................................................... 7

Figure 2: Example of a downtrend turning into an uptrend................................................................... 9

Figure 3: A long term Channel line, support and resistance level......................................................... 10

Figure 4: head and shoulders pattern. .................................................................................................. 10

Figure 5: Example of a double top. Sometimes the second peak doesn't quite reach the first peak as in

this example. The actual signal was the breaking of support near 44.6 .............................................. 11

Figure 6: Example of a descending triangle. Notice the flat bottom line and the declining upper line.

This is usually a bearish pattern............................................................................................................ 12

Figure 7: Basic Elliot Wave pattern ....................................................................................................... 14

Figure 8: Expanded Elliot wave pattern ................................................................................................ 15

Figure 9: Trends and turns .................................................................................................................... 16

Figure 10: MACD Buy-Sell signals ...................................................................................................... 19Figure 11: RSI Buy- Sell signals ........................................................................................................... 20

Figure 12: Basic Candlestick explained................................................................................................. 24

Figure 13: Long and Short Days ............................................................................................................ 24

Figure 14: Shooting Star........................................................................................................................ 26

Figure 15: Harami Pattern .................................................................................................................... 26

Figure 16: Three day candle stick patterns ........................................................................................... 27

Figure 17: Engulfing Patterns................................................................................................................ 27

Figure 18: USD-INR Elliot Wave chart................................................................................................... 28

Figure 19: RSI Buy - Sell calls for USD- INR ............................................................................................ 29

Figure 20: MACD Buy- Sell signals ......................................................................................................... 30

Figure 21: Long term Moving Average Trend....................................................................................... 31

Figure 22: Double Moving Average trend............................................................................................. 32

Figure 23: Triple Moving Average trend............................................................................................... 33

Figure 24: MA envelope ........................................................................................................................ 34

Figure 25: Bollinger Bands .................................................................................................................... 35

Figure 26: 3 month daily candle stick chart with a 5-day moving average .......................................... 36
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ABSTRACT

This report aims at introducing the subject of technical analysis in the foreign exchange market, with

emphasis on its charting techniques and some of the relevant patterns that help traders forecast

trends and take trading decisions. The initial part of the report aims at providing a theoretical base

for technical analysis in terms of its use in the foreign exchange market. This is followed by an

attempt to identify the important patterns and trends in the most recent charts for the Dollar Rupee

exchange rate.

KEY WORDS: Exchange rate, technical analysis, forecasts, charting techniques

JEL Classification: F31, G15


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Section 1: Introduction: Foreign Exchange Market O verview

The volume of international transactions has grown enormously since the end of World War II.

International trade and investment would not be possible without the ability to buy and sell foreign

currencies. Currencies may be bought and sold because no one currency is the acceptable means of

payment among countries.

The trading of currencies takes place in the foreign exchange markets whose primary function is to

facilitate international trade and investment. In international transactions, at least one party is

dealing in a foreign currency. The purpose of forex markets is thus to permit transfers of purchasing

power denominated in one currency to another.

Most currency transactions in the forex market are channelled through the worldwide interbank

market, the wholesale market in which major banks trade with one another. The foreign exchange

market is not a physical place, rather, it is an electronically linked network of banks, foreign

exchange brokers, and dealers whose function is to bring together buyers and sellers of foreign

exchange. It is not confined to any one country but is dispersed throughout the leading financial

centres in the world: London, New York city, Paris, Zurich, Amsterdam, Tokyo, Toronto, etc.

The major participants in the forex markets are the large commercial banks, foreign exchange

brokers in the interbank market, commercial customers, primary multinational corporations, and

central banks, which intervene from time to time to smooth exchange rate fluctuations or to

maintain target exchange rates. Only the head offices or regional offices of major commercial banks

are actually market makers-that is, actively deal in foreign exchange for their own accounts. Most

small banks typically have a credit line with a large bank or with their home office. The various

linkages between banks and their customers are depicted below:

Stockbroker

Money Market,

Stock Market,

Foreign

Customer

buying $(say)

Local Bank

Major Banks

interbank

StockbrokerLocal Banks

Customer selling

$(say)

Stockbroker

Money Market,

Stock Market,

Foreign

Customer

buying $(say)

Local Bank

Major Banks

interbank


Customer selling

$(say)

Stockbroker

Money Market,

Stock Market,

Foreign

Exchange Broker

Customer

buying $(say)

Local Bank

Major Banks

interbank


Customer selling

$(say)


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Section 2: Technical Analysis in Forex Markets

The statement "market action discounts everything" forms what is probably the cornerstone of technical

analysis. [...] The technician believes that anything that can possibly affect the price--fundamentally,politically, psychologically, or otherwise--is actually reflected in the price of that market."

Murphy (1999)

Technical analysis is a method of predicting price movements and future market trends by

studying charts of past market action. Technical analysis is concerned with what has actually

happened in the market, rather than what should happen and takes into account the price of

instruments and the volume of trading, and creates charts from that data to use as the primary tool.

A technical trading rule (TTR), for example, might suggest buying a currency if its price has risen

more than 1% from its value five days earlier. Traders in stock, commodity and foreign exchange

markets use such rules widely.The essence of the trade on the basis of this type of analysis of the

Forex is to conduct mathematical calculations and the construction of geometric figures that explain

what is happening in the market as will be explained in the succeeding sections.

Technical methods date back at least to 1700, but the Dow Theory, proposed by Wall Street

Journaleditors Charles Dow and William Peter Hamilton, popularized them in the late nineteenth

and early twentieth century. Although modern technical analysis was originally developed in the

context of the stock market, its advocates argue that it applies in one form or another to all asset

markets. Since the era of floating exchange rates began in the early 1970s, foreign currency traders

have widely adopted this approach to trading. At least some technicians clearly believe that the

foreign exchange market is particularly prone to trending.

Currencies have the tendency to develop strong trends, stronger than stocks in my opinion because

currencies reflect the performance of countries. (Jean-Charles Gand, Socit Gnrale Gestion, inClements

The basic premise underlying technical analysis is as follows:

Market action discounts everything!: This means that the actual price is a reflection ofeverything that is known to the market that could affect it, for example, supply and demand,

political factors and market sentiment. However, the pure technical analyst is only

concerned with price movements, not with the reasons for any changes.

Prices move in trends:Technical analysis is used to identify patterns of market behaviourthat have long been recognized as significant. For many given patterns there is a high

probability that they will produce the expected results. Also, there are recognized patterns

that repeat themselves on a consistent basis.

History repeats itself: Forex chart patterns have been recognized and categorized for over100 years and the manner in which many patterns are repeated leads to the conclusion that

human psychology changes little over time.


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Figure 1: Technical analysis is based on the premise that markets trend and that those trends tend to persist.

The skills of a technical analyst are used primarily to help determine the highest-probability

reactions to past and current price movement, as well as likely future price movement. Therefore,

technical analysis is less about actually predicting the future and more about finding high-probability

potential opportunities to trade in the financial markets.

Technical analysis used today has its origins in the famous Dow Theory. In the words of Charles Dow:

The market is always considered as having three movements, all going at the same time. The first is the

narrow movement from day to day. The second is the short swing, running from two weeks to a month ormore; the third is the main movement, covering at least four years in its duration.

Proponents of the Dow Theory refer to the three movements as:

1. Daily fluctuations that are random day to day wiggles.2. Secondary movements or corrections that may last a few weeks to some months; and3. Primary trends representing the bull and the bear phases of the market.

An upward primary trend represents a bull market and a downward primary trend represents a bear

market. A major upward move is set to occur when the high point of each rally is higher than the

high point of the preceding rally. And the low point of each rally is lower than the low point of thepreceding rally. The opposite holds true for a major downward trend.

The secondary movement represents a correction. They represent adjustments to excesses that may

have occurred in the primary movements

Section 2.1: The Need for Technical analysis in the Foreign exchange Markets

The widespread use of technical analysis in foreign exchange (and other) markets is puzzling because

it implies that either traders are irrationally making decisions on useless information or that past

prices contain useful information for trading. The latter possibility would contradict the efficientmarkets hypothesis, which holds that no trading strategy should be able to generate unusual profits


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on publicly available informationsuch as past pricesexcept by bearing unusual risk. And the

observed level of risk-adjusted profitability measures market efficiency. Therefore much research

effort has been directed toward determining whether technical analysis is indeed profitable or not.

One of the earliest studies, by Fama and Blume (1966), found no evidence that a particular class of

TTRs could earn abnormal profits in the stock market.

An important area of research on technical analysis has focused on documenting how and to what

extent it is actually used in foreign exchange markets. This research is primarily conducted through

surveys of technicians. Allen and Taylor (1990) and Taylor and Allen (1992) conduct the first such

surveys on chief foreign exchange dealers in London. The responses established that almost all

traders in the London foreign exchange market use technical analysis to some degree and that they

tend to combine it with fundamental analysis. So there is not an exclusive reliance on either

approach to trading. In addition, the authors find that the relative weight attached to technical

analysis is greater at shorter horizons.

Section 2.2: Technical versus Fundamental analysis

While technical analysis concentrates on the study of market action, fundamental analysis focuses

on the economic forces of supply and demand that cause prices to move higher, lower, or stay the

same.

The fundamental approach examines all of the relevant factors affecting the price of a market in

order to determine the intrinsic value of that market. The intrinsic value is what the fundamentals

indicate something is actually worth based on the law of supply and demand. If this intrinsic value is

under the current market price, then the market is overpriced and should be sold. If market price is

below the intrinsic value, then the market is undervalued and should be bought.

Both of these approaches to market forecasting attempt to solve the same problem, that is, to

determine the direction prices are likely to move. They just approach the problem from different

directions. The fundamentalist studies the cause of market movement, while the technician studies

the effect. The technician, of course, believes that the effect is all that he or she wants or needs to

know and that the reasons, or the causes, are unnecessary. The fundamentalist always has to know

why.


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Section 3: Basic Technical Analysis Patterns

The concept oftrendis absolutely essential to the technical approach to market analysis. All of the

tools used by the chartist support and resistance levels and price patterns, etc.-have the sole

purpose of helping to measure the trend of the market for the purpose of participating in that trend.

Many different kinds of patterns have been identified which are regularly used by technical analysts.

The objective is to predict the major components of the trend: its direction, its level and the timing.

Some of the most widely known include:

Uptrendwould be defined as a series of successively higher peaks and troughs Downtrendis just the opposite, a series of declining peaks and troughs Horizontal peaks and troughs would identify a sideways price trend. This type of sideways

action reflects a period of equilibrium in the price level where the forces of supply and

demand are in a state of relative balance

Figure 2: Example of a downtrend turning into an uptrend

Support / Resistance levelsThe Support level is the lowest price an instrument trades at over a period of time. The longer

the price stays at a particular level, the stronger the support at that level. On the chart this is

price level under the market where buying interest is sufficiently strong to overcome selling

pressure. Some traders believe that the stronger the support at a given level, the less likely it will

break below that level in the future. The Resistance level is a price at which an instrument or

market can trade, but which it cannot exceed, for a certain period of time. On the chart this is a

price level over the market where selling pressure overcomes buying pressure, and a priceadvance is turned back.

Downtrend

Sideways

Uptrend


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The channel line, or the return line as it is sometimes called, is another useful variation ofthe trendline technique. Sometimes prices trend between two parallel lines-the basic

trendline and the channel line.

Figure 3: A long term Channel line, support and resistance level

Head and Shoulder patternA head and shoulders pattern is also a trend reversal formation. It is formed by a peak (shoulder),

followed by a higher peak (head), and then another lower peak (shoulder). A neckline is drawn by

connecting the lowest points of the two troughs. The slope of this line can either be up or down.When the slope is down, it produces a more reliable signal.

Figure 4: head and shoulders pattern.

In this example, we can visibly see the head and shoulders pattern. The head is the 2nd peak and isthe highest point in the pattern. The two shoulders also form peaks but do not exceed the height of

Support

level

Resistance

level

Shoulder 1

Head

Shoulder 2


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the head. The head and shoulder pattern represents a bearish development. If the price falls below

the neckline, a price decline is expected. Hence, it is a signal to sell.

Double Top/Double BottomFor obvious reasons, the top is often referred to as an "M" and the bottom as a "W."The generalcharacteristics of a double top are similar to that of the head and shoulders except that only two

peaks appear instead of three. In an uptrend (as shown below)the market sets a new high at point

A, and then declines to point B. So far, everything is proceeding as expected in a normal uptrend.

The next rally to point C, however, is unable to penetrate the previous peak at A on a closing basis

and begins to fall back again. A potential double top has been set up.

Figure 5: Example of a double top. Sometimes the second peak doesn't quite reach the first peak as in this example. The

actual signal was the breaking of support near 44.6

TrianglesThere are three types of triangles-symmetrical, ascending, and descending. Each type of triangle

has a slightly different shape and has different forecasting implications.

The symmetrical triangle (or the coil) is usually a continuation pattern. It represents a pause in theexisting trend after which the original trend is resumed.

The ascending and descending triangles are variations of the symmetrical, but have different

forecasting implications. The upper trendline is flat, while the lower line is rising. This pattern

indicates that buyers are more aggressive than sellers. It is considered a bullish pattern and is usually

resolved with a breakout to the upside.

Both the ascending and descending triangles differ from the symmetrical in a very important sense.

No matter where in the trend structure the ascending or descending triangles appear, they have

very definite forecasting implications. The ascending triangle is bullish and the descending triangle is

bearish

B

A

C


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The figure below shows a descending triangle. This pattern indicates that sellers are more aggressive

than buyers, and is usually resolved on the downside. The downside signal is registered by a decisive

close under the lower trendline.

Figure 6: Example of a descending triangle. Notice the flat bottom line and the declining upper line. This is usually a

bearish pattern.


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Section 4: T echnical Analysis: Charting T echniques

Various charting techniques used in technical analysis can be categorized as follows.each will be

explained in the succeeding sections:

Cycle based: Example: Elliot Wave. Momentum based: Example: MASD, RSI Trend based: Example: Moving Averages Chart based: Example: Candlestick, etc

Section 4.1:Cycle based indicators

A cycle is a term to indicate repeating patterns of market movement, specific to recurrent events,

such as seasons, elections etc. Many markets have a tendency to move in cyclical patterns. Cycle

indicators determine the timing of a particular market pattern.

Section 4.1.1: Elliot Wave theory"The Wave Principle" is Ralph Nelson Elliott's discovery that social, or crowd, behaviour trends and

reverses in recognizable patterns. Using stock market data as his main research tool, Elliott

discovered that the ever-changing path of stock market prices reveals a structural design that in turnreflects a basic harmony found in nature. From this discovery, he developed a rational system of

market analysis.

Elliott isolated thirteen patterns of movement, or "waves," that recur in market price data and are

repetitive in form, but are not necessarily repetitive in time or amplitude. He named, defined and

illustrated the patterns. He then described how these structures link together to form larger versions

of those same patterns, how they in turn link to form identical patterns of the next larger size, and

so on.

In a nutshell, then, the Wave Principle is a catalog of price patterns and an explanation of where

these forms are likely to occur in the overall path of market development. Elliott's descriptionsconstitute a set of empirically derived rules and guidelines for interpreting market action. Elliott

claimed predictive value for The Wave Principle, which now bears the name, "The Elliott Wave

Principle."

Elliott was very much influenced by the Dow Theory, which has much in common with the Wave

Principle. Elliott goes on to say that the Wave Principle was a much needed complement to the Dow

Theory.


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Basic Tenets of Elliott wave principleThere are three important aspects of wave theory-pattern, ratio, and time-in that order of

importance. Pattern refers to the wave patterns or formations that comprise the most important

element of the theory. Ratio analysis is useful in determining retracement points and price

objectives by measuring the relationships between the different waves. Finally, time relationships

also exist and can be used to confirm the wave patterns and ratios, but are considered by some

Elliotticians to be less reliable in market forecasting.

Interpretation

The underlying forces behind the Elliott Wave Theory are of building up and tearing down. The basic

concepts of the Elliott Wave Theory are listed below.

Action is followed by reaction. There are five waves in the direction of the main trend followed by three corrective waves (a

5-3 move).

A 5-3 move completes a cycle. This 5-3 move then becomes two subdivisions of the nexthigher 5-3 wave.

The underlying 5-3 pattern remains constant, though the time span of each may vary. The basic pattern is made up of eight waves (five up and three down) which are labeled 1, 2,

3, 4, 5, a, b, and c on the following chart.

Figure 7: Basic Elliot Wave pattern

Waves 1, 3, and 5 are called impulse waves. Waves 2 and 4 are called corrective waves. Waves a, b,

and c correct the main trend made by waves 1 through 5. The main trend is established by waves 1

through 5 and can be either up or down. Waves a, b, and c always move in the opposite direction ofwaves 1 through 5.


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Elliott Wave Theory holds that each wave within a wave count contains a complete 5-3 wave count

of a smaller cycle. The longest wave count is called the Grand Supercycle. Grand Supercycle waves

are comprised of Supercycles, and Supercycles are comprised of Cycles. This process continues into

Primary, Intermediate, Minute, Minuette, and Sub-minuette waves. The following chart shows how

5-3 waves are comprised of smaller cycles.

Figure 8: Expanded Elliot wave pattern

This chart contains the identical pattern shown in the preceding chart (now displayed using dotted

lines), but the smaller cycles are also displayed. For example, you can see that impulse wave labeled1 in the preceding chart is comprised of five smaller waves.

Fibonacci numbers provide the mathematical foundation for the Elliott Wave Theory. Briefly, the

Fibonacci number sequence is made by simply starting at 1 and adding the previous number to

arrive at the new number (i.e., 0+1=1, 1+1=2, 2+1=3, 3+2=5, 5+3=8, 8+5=13, etc).

Each of the cycles that Elliott defined are comprised of a total wave count that falls within the

Fibonacci number sequence. For example, the preceding chart shows two Primary waves (an impulse

wave and a corrective wave), eight intermediate waves (the 5-3 sequence shown in the first chart),

and 34 minute waves (as labeled).The numbers 2, 8, and 34 fall within the Fibonacci numbering

sequence. Elliott Wave practitioners use their determination of the wave count in combination withthe Fibonacci numbers to predict the time span and magnitude of future market moves ranging from

minutes and hours to years and decades.

There is general agreement among Elliott Wave practitioners that the most recent Grand Supercycle

began in 1932 and that the final fifth wave of this cycle began at the market bottom in 1982.

However, there has been much disparity since 1982. Many heralded the arrival of the October 1987

crash as the end of the cycle. The strong recovery that has since followed has caused them to

reevaluate their wave counts. Herein, lies the weakness of the Elliott Wave Theory its predictive

value is dependent on an accurate wave count. Determining where one wave starts and another

wave ends can be extremely subjective.


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Trends and Turns

The analysts first task is to look at charts of market action and identify any completed five-wave andthree-wave structures. Only then can he interpret where the market is and where its likely to go.

Figure 9: Trends and turns

Say were studying a market that has reached the point shown in the above figure. So far weve

seen a five-wave move up, followed by a three-wave move down. But this is not the only possible

interpretation. It is also possible that wave (2) hasnt ended yet; it could develop into a more

complex three-wave structure before wave (3) gets underway. Another possibility is that the waveslabeled (1) and (2) are actually waves (A) and (B) of a developing three-wave upward correction

within a larger impulsive downtrend, as shown in the Alternate interpretation at the bottom of the

chart. According to each of these interpretations though, the next imminent movement is likely to

be upward.

This illustrates an important point concerning the Wave Principle. It does not provide certaintyabout

any one market outcome. Instead, it gives you an objective means of determining the probabilityof

a future direction for the market. At any time, two or more valid wave interpretations usually exist.

So its important for the investor to carefully assess the probability of each interpretati on. View the

Wave Principle as your road map to the market and your investment idea as a trip. You start the trip

with a specific plan in mind, but conditions along the way may force you to alter your course.Alternate counts are simply side roads that sometimes end up being the best path. Elliotts highly

specific rules keep the number of valid interpretations to a minimum. The analyst usually considers

as preferred the one that satisfies the largest number of guidelines.

The top alternate is the one that satisfies the next largest number of guidelines, and so on.

Alternates are an essential part of using the Wave Principle. They are not bad or rejected wave

interpretations. Rather, they are valid interpretations that are given lower probability while the

count works itself out. If the market doesnt follow the original preferred scenario, the top alternate

usually becomes the preferred.

Elliotts rules give specific make-or-break levels for a given interpretation. In the figure, forexample, if the move labeled wave (2) continues below the level of the beginning of wave(1), then


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the originally preferred interpretation would be instantly invalidated. By eliminating subjectivity, the

rules help you firm up your investment strategy and reduce your risk.

Fibonacci ratios and retracements apply to both price and time, although the former is considered to

be the more reliable. Fibonacci sequence which begins with the number 1 and in which each

subsequent number is the sum of the previous two: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 and so on. Thesequence in turn gives rise to several unique ratios, including .618, .382 and 1.618 the Golden

Ratio. These ratios exist throughout nature, in everything from population growth to the physical

structure within the human brain, the DNA helix, many plants and even the cosmos itself. The

following are among the most commonly used Fibonacci ratios:

One of the three impulse waves sometimes extends. The other two are equal in time andmagnitude. If wave 5 extends, waves 1 and 3 should be about equal. If wave 3 extends,

waves 1 and S tend toward equality.

A minimum target for the top of wave 3 can be obtained by multiplying the length of wave 1by 1.618 and adding that total to the bottom of 2.

The top of wave 5 can be approximated by multiplying wave 1 by 3.236 (2xl.618) and addingthat value to the top or bottom of wave 1 for maximum and minimum targets.

Where waves 1 and 3 are about equal, and wave 5 is expected to extend, a price objectivecan be obtained by measuring the distance from the bottom of wave 1 to the top of wave 3,

multiplying by 1.618, and adding the result to the bottom of 4.

For corrective waves, in a normal 5-3-5 zig-zag correction, wave c is often about equal to thelength of wave a.

Another way to measure the possible length of wave c is to multiply .618 by the length ofwave a and subtract that result from the bottom of wave a.

In the case of a flat 3-3-5 correction, where the b wave reaches or exceeds the top of wavea, wave c will be about 1.618 the length of a.

In a symmetrical triangle, each successive wave is related to its previous wave by about .618.Elliott had two chief insights concerning Fibonacci relationships within waves. First, corrective waves

tend to retrace prior impulse waves of the same degree in Fibonacci proportion. For example, wave

(2) in the figure retraces 38% of wave (1).Thats a common relationship. Other frequent wave

relationships are 50% and 62%. Second, impulse waves of the same degree within a larger impulse

sequence tend to be related to one another in Fibonacci proportion.

Section 4.2:Momentum Indicators

Momentum is a general term used to describe the speed at which prices move over a given period oftime period. Momentum indicators determine the strength or weakness of a trend as it progresses

over time. Momentum is highest at the beginning of a trend and lowest at trend turning points. Any

divergence of directions in price and momentum is a warning of weakness; if price extremes occur

with weak momentum, it signals an end of movement in that direction. If momentum is trending

strongly and prices are flat, it signals a potential change in direction. A couple of technical analysis

methods based on momentum described below are MACD & RSI.


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Section 4.2.1:MACD: Moving Average Convergence DivergenceOverviewThe MACD ("Moving Average Convergence/Divergence") is a trend following momentum indicator

that shows the relationship between two moving averages of prices. The MACD was developed by

Gerald Appel. The MACD is the difference between a 26-day and 12-day exponential moving

average. A 9-day exponential moving average, called the "signal" (or "trigger") line is plotted on top

of the MACD to show buy/sell opportunities. (Appel specifies exponential moving averages as

percentages. Thus, he refers to these three moving averages as 7.5%, 15%, and 20% respectively.)

InterpretationThe MACD proves most effective in wide-swinging trading markets. There are three popular ways to

use the MACD: crossovers, overbought/oversold conditions, and divergences.

Crossovers

The basic MACD trading rule is to sell when the MACD falls below its signal line. Similarly, a buy

signal occurs when the MACD rises above its signal line. It is also popular to buy/sell when the MACD

goes above/below zero.

Overbought/Oversold Conditions

The MACD is also useful as an overbought/oversold indicator. When the shorter moving average

pulls away dramatically from the longer moving average (i.e., the MACD rises), it is likely that the

security price is overextending and will soon return to more realistic levels. MACD overbought and

oversold conditions exist vary from security to security.

DivergencesAn indication that an end to the current trend may be near occurs when the MACD diverges from

the security. A bearish divergence occurs when the MACD is making new lows while prices fail to

reach new lows. A bullish divergence occurs when the MACD is making new highs while prices fail to

reach new highs. Both of these divergences are most significant when they occur at relatively


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Figure 10: MACD Buy-Sell signals

CalculationThe MACD is calculated by subtracting the value of a 26-day exponential moving average from a 12-

day exponential moving average. A 9-day dotted exponential moving average of the MACD (the

"signal" line) is then plotted on top of the MACD.

Section 4.2.2:RSI: Relative Strength Index

OverviewThe Relative Strength Index ("RSI") is a popular oscillator. It was first introduced by Welles Wilder in

an article in Commodities (now known as Futures) Magazine in June, 1978. Step-by-step instructions

on calculating and interpreting the RSI are also provided in Mr. Wilder's book, New Concepts inTechnical Trading Systems. The name "Relative Strength Index" is slightly misleading as the RSI does

not compare the relative strength of two securities, but rather the internal strength of a single

security. A more appropriate name might be "Internal Strength Index."

InterpretationWhen Wilder introduced the RSI, he recommended using a 14-day RSI. Since then, the 9-day and 25-

day RSIs have also gained popularity. The fewer days used to calculate the RSI, the more volatile the

indicator.

The RSI is a price-following oscillator that ranges between 0 and 100. A popular method of analyzing

the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing tosurpass its previous high. This divergence is an indication of an impending reversal. When the RSI


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then turns down and falls below its most recent trough, it is said to have completed a "failure

swing." The failure swing is considered a confirmation of the impending reversal. In Mr. Wilder's

book, he discusses five uses of the RSI in analyzing commodity charts. These methods can be applied

to other security types as well.

Tops and Bottoms:The RSI usually tops above 70 and bottoms below 30. It usually forms these tops and bottomsbefore the underlying price chart.

Chart Formations:The RSI often forms chart patterns such as head and shoulders or triangles that may or may not

be visible on the price chart.

Failure Swings:This is where the RSI surpasses a previous high (peak) or falls below a recent low (trough).

Support and Resistance:The RSI shows, sometimes more clearly than price themselves, levels of support and resistance.

Divergences:As discussed above, divergences occur when the price makes a new high (or low) that is not

confirmed by a new high (or low) in the RSI. Prices usually correct and move in the direction ofthe RSI.

Figure 11: RSI Buy- Sell signals

CalculationThe RSI is a fairly simple formula, but is difficult to explain without pages of examples. Refer to

Wilder's book for additional calculation information. The basic formula is:

where RS is the average ofN days up closes divided by average of N days down closes and N is a

predetermined number of days.


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Section 4.3:Trend approach to technical analysis

A trend refers to the direction of exchange rates. Rising peaks and troughs constitute an uptrend

(bullish) while falling peaks and troughs constitute a downtrend (bearish). Breaking of a trendline

indicates a trend reversal. Horizontal peaks and troughs indicate a ranging market.

Moving averages based analysis is used to smoothen rate information in order to confirm the trends

and support-resistance levels. They are also useful in deciding on a trading strategy. Recognizing a

trend can be done using standard deviation which is a measure of volatility. Bollinger bands illustrate

trends with this approach. When markets become more volatile, bands widen, while during less

volatile periods, bands move closer to the average and hence contract.

Section 4.3.1: Moving AveragesMoving Average method of Technical Analysis is a perfectly structured tool that follows the old

saying of successful trading Let profit run, while cutting losses. The tool is an essentially trend

following device and is used extensively to identify when a new signal has begun or an old signal has

reversed. The Moving Average at best just indicates a signal change, following the leads from the

past data and it is generally used in conjunction with other technical analysis devices to make a

trading decision in the Forex Market.

The ConceptMathematically, the Moving Average is a simple averaging system where the exchange rates over a

fixed period are averaged out. The average keeps on moving in the sense that for the calculation of

new average, the earliest rate is removed and the latest rate included maintaining the constant

length for the period.

Types of Moving AverageMoving Average is a smoothening device which by averaging the data makes it easier to view the

underlying trend. There are different types of Moving Average based on the technique of the noise

reduction. Though the logic is same for every case Averaging & Smoothening Rates

Simple Moving Average In financial applications a simple moving average (SMA) is theunweighted mean of the previous n data points. An example of a simple unweighted running

mean for a 10-day sample of closing price is the mean of the previous 10 days' closing prices.

If those prices are then the formula is

Linearly Weighting Moving Average - In technical analysis of FOREX data, a weightedmoving average (WMA) has the specific meaning of weights that decrease in arithmetical

progression. In an n-day WMA the latest day has weight n, the second latest n 1, etc, down

to one.


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Exponential Moving Average - An exponential moving average (EMA) is a type of filter thatapplies weighting factors which decrease exponentially. The weighting for each older data

point decreases exponentially, never reaching zero.

The EMA for a series Ymay be calculated recursively:

S1 = Y1 for

where :

The coefficient represents the degree of weighting decrease, a constantsmoothing factor between 0 and 1. A higher discounts older observations faster.

Alternatively, may be expressed in terms ofN time periods, where = 2/(N+1). For

example, N = 19 is equivalent to = 0.1. The half-life of the weights (the interval

over which the weights decrease by a factor of two) is approximately N/2.8854

(within 1% ifN > 5).

Yt is the observation at a time period t. St is the value of the EMA at any time period t

Other than the above three types, there are a couple of more Moving Average methods Least

square MA & Adaptive MA. These methods are more complex in nature and not very popular among

the common traders.

Key Parameters of MAWhile performing a MA analysis over the exchange rate, it is important for an analyst to decide on

the below mentioned criteria.

Length of PeriodWhile there are a lot of theories for deciding the length of the period to be averaged out, the

decision of choosing a particular factor is based on the following factors:

Time Frame of the Trade :The length of the MA should ideally be in synch with the timeframe for which a trader is eying the market. For example, a day trader will use a much

shorter average than a short-term trader

Purpose of the Transaction: If the purpose is long term investment then identifying a longterm trend would be ideal. Depending on this a period can be long, medium or short term.

The decision on the period also depends on the kind of the chart whether it is

daily/weekly/monthly basis and so on.

Generally the popular harmonics used as periods are 5, 10, 20 & 40. Another common practice is to

use the numbers from Fibonacci Series. The Fibonacci numbers have proven quite successful over

the years and they find their justification in the Elliott Wave Principle.

Longer Period vs Shorter PeriodThe longer averages work better as long as the trend remains in force, but a shorter average is

better when the trend is in the process of reversing. A shorter average gives earlier signals. The


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longer average is slower, but more reliable. Thus, the trade off while making a choice of the period

length is that a shorter trend follows market more closely while a longer trend is more reliable.

Rate used for calculationWhile choosing the Rate to be averaged, a number of combinations can be formed depending on

high, low, open or close rates.

In sum, most common methods for calculating moving averages are calculating them from:

Close (by far the most popular) Average of high and low = (H+L)/2 Average of high, low, and close, also called typical price = (H+L+C)/3 Average of open, high, low, and close = (O+H+L+C)/4

The decision on the Rate to be considered is in fact more subjective than length of the period. The

most common method includes using closing price or average of high and low. Again the choice

depends on the individual investors preference and strategy. For example in case of intraday

transactions, the closing price is less significant. In most cases the length of moving average period

influences the behaviour of the moving average much more than which price is used for its

calculation.

With improvement in technology and availability of information, some investors actually look

forward to Volume of Trade to detect the trend. For such investors, the trend of the Exchange Rate

itself becomes irrelevant.

Section 4.4: Chart Based Indicators

Forex charts are based on market action involving exchange rates. Charts help to visually analyze

market conditions, assess and create forecasts and identify behaviour patterns. They present the

behaviour of currency exchange rates over time. Rates are measured on the vertical axis and time is

measured on the horizontal axis. The technical analyst analyses the micro environment, trying to

match the actual occurrence with known patterns.

The appropriate time scale to be used on the chart depends on the traders strategy. Short

range investor would probably select a day chart (units of hours/minutes) while a

medium/long range investor would use weekly/monthly charts.

Section 4.4.1: Candlestick Charts

Candlestick charts track the movement of the prices of securities or the exchange rates.

These charts are easier to read and can be understood at a glance since they are visually

more appealing. The information displayed is more easily interpreted and understood.


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The figure above shows how a candlestick chart is made. The rectangle represents the

difference between the open and close price for the day, and is called the body. Notice that

the body can be either black or white. A white body (or not filled) means that the close price

was greater (higher) than the open price. The black body means that the close price was

lower than the open price. The small lines above and below the body are referred to as

wicks or hairs or shadows.

Thus, when we are drawing the chart for USD/INR exchange rate, a higher price corresponds

to a higher exchange rate while a lower price corresponds to a lower exchange rate whenthe rate is quoted in direct method.

Interpretation of candlesticks

Different body/shadow combinations have different meanings. Days in which the difference

between the open and close value is great are called Long Days. Likewise, days in which the

Difference between the open and close value is small, are called Short Days.

The size being referred to here is the size of the rectangle which does not include the wicks.

Spinning Tops are days in which the candlesticks have small bodies with upper and lower

shadows that are of greater length than that of the body. The body color is relatively

unimportant in spinning top candlesticks. These candlesticks are considered as days of

indecision.

When the open rate and the close rate are equal, they are called Doji lines. Doji candlesticks

can have shadows of varying length. When referring to Doji candlesticks, there is someconsideration as to whether the open and close rate must be exactly equal. This is a time

Figure 12: Basic Candlestick explained

Figure 13: Long and Short Days Figure 14: Spinning Tops


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when the rates must be almost equal, especially when dealing with large rate movements.

There are different Doji candlesticks that are important. The Long-legged Doji has long

upper and lower shadows and reflects considerable indecision on the part of market

participants. The Gravestone Dojihas only a long upper shadow and no lower shadow. The

longer the upper shadow, more bearish is the interpretation. The Dragonfly Doji is the

opposite of the Gravestone Doji, the lower shadow is long and there is no upper shadow. Itis usually considered quite bullish.

A few Candlestick patterns

Dark Cloud CoverThis is a two day reversal pattern that has bearish implications. The first day of this pattern

is a long white candlestick. This reflects the current trend of the market and helps confirm

the uptrend (or rupee depreciation) to traders. The next day opens above the high rate of

the previous day. However, trading for the rest of the day is lower with a closing rate at

least below the midpoint of the body of the first day. This is a significant blow to the bullish

mentality and will force many to exit the market. Since the closing rate is below the opening

rate on the second day,the body is black. This is the dark cloud referred to in the name.

Piercing LineThe opposite of the Dark Cloud Cover, the Piercing Line, has bullish implications. The

scenario is quite similar, but opposite. A downtrend is in place, the first candlestick is a long

black day which solidifies traders' confidence in the downtrend. The next day, exchange

rates open at a new low and then trade higher all day and close above the midpoint of the

first candlestick's body. This offers a significant change to the downtrend mentality and

many will reverse or exit their positions.

Evening Star and Morning StarThe Evening Star and its cousin, the Morning Star, are two powerful reversal candle

patterns. These are both three day patterns that work exceptionally well. The Evening Star is

a bearish reversal candle pattern. The first day of this pattern is a long white candlestick

which fully enforces the current uptrend or a depreciating rupee. On the open of the second

day, prices gap up above the body of the first day. Trading on this second day is somewhat

restricted and the close price is near the open price while remaining above the body of the

first day. The body for the second day is small. This type of day following a long day is

referred to as a Star pattern. A Star is a small body day that gaps away from a long body day.

The third and last day of this pattern opens with a gap below the body of the star and closeslower with the close price below the midpoint of the first day.

Figure 15: Doji Candlesticks


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Shooting StarA single day pattern that can appear in an uptrend. It opens higher, trades much higher,

then closes near its open. The long upper wick of the candlestick pattern indicates that the

buyers drove prices up at some point during the period in which the candle was formed but

encountered selling pressure which drove prices back down for the period to close near to

where they opened. As this occurred in an uptrend the selling pressure is seen as a potential

reversal sign. When encountering this pattern traders will look for a lower open on the next

period before considering the pattern valid and potentially including it in their tradingstrategy.

Figure 14: Shooting Star

HaramiA two day pattern that has a small body day completely contained within the range of the

previous body, and is of the opposite color.

Figure 15: Harami Pattern

Figure 16: Evening Star and Morning Star


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Three Black Crows:A bearish reversal pattern consisting of three consecutive long black bodies where each day

closes at or near its low and opens within the body of the previous day.

Three White Soldiers:A bullish reversal pattern consisting of three consecutive long white bodies. Each shouldopen within the previous body and the close should be near the high of the day.

Figure 16: Three day candle stick patterns

Engulfing Pattern:A reversal pattern that can be bearish or bullish, depending upon whether it appears at the

end of an uptrend (bearish engulfing pattern) or a downtrend (bullish engulfing pattern). The

first day is characterized by a small body, followed by a day whose body completely engulfs

the previous day's body.

Figure 17: Engulfing Patterns
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Section 5: Practical Application to C urrent trends in the Foreign Exchange M arket

Research MethodologyWe used the charts feature available at http://www.forexpros.com/ to plot the Dollar Rupeemovement over the last one year. Certain inbuilt features available for drawing candlestick, MACD,

RSI etc have been used .Then we have made an attempt at applying the various techniques which

yield technical indicators like momentum based, cycle based, chart based and moving average based

indicators, all of which have been described before. We have tried to identify potential buy-sell

points at different times of the year for USD-INR movement as indicated by the different indicators

under the different methods.

Section 5.1:Cycle Based

Section 5.1.1: Elliot wave

Figure 18: USD-INR Elliot Wave chart

The above chart shows the Elliot wave 5-3 pattern for the US dollar Indian Rupee movement for a

period between October and December, 2010. The Elliot wave pattern as highlighted in red started

around the 5th of November and completed the entire cycle around 10 th of December. As we can

see, the wave 1 which started out on 5th

November from Rs.43.9 /$ rallied to around 44.30 within

the week and the paused for a while and declining a little but not below the Fibonacci retracement
http://www.forexpros.com/http://www.forexpros.com/http://www.forexpros.com/


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levels forming the wave 2. Then there was a rally which formed the wave3 and as generally expected

is the biggest move in the Elliots wave formation. Dollar continued to appreciate for the entire week

before it paused around the 17th November to retrace a little and form the wave4. Then the uptrend

continued post that though at a slower pace than wave3 to form wave5. The reversal of wave 4 and

the initiation of wave5 would have been a good opportunity to buy US dollars and hold keeping a

tight stop-loss so that when the wave5 trend reverses, you can immediately exit the trade.

Around the end of November, the wave5 reversed to form the top and the waves a, b and c. A trader

who would have identified the 5 wave pattern on the uptrend could have clearly sold dollar and

brought rupees at the onset of the end of wave5.

Section 5.2: Momentum Based

Section 5.2.1:Relative Strength Index

Figure 19: RSI Buy - Sell calls for USD- INR

The above graph dates back to end of March, 2011 to May, 2011. Based on a momentum indicator

like RSI a trader could have taken buy and sell calls and which would have proved fruitful as well.

Looking closely, we can see that the RSI index value went below a value of 30 and it was also below

the 9-day moving average on 7th April, 2011. This is clearly a buy signal for the trader to buy dollar

and sell Rupee at Rs. 44.050/$ level. Post this buy call, we see that the RSI index value remains in theband between 30 and 70 till about 24th May when USD-INR hits Rs. 45.25/$. At this point the RSI


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index value crosses the threshold of 70 and as it also lies above the 9 day moving average, signaling a

sell dollar and buy rupee signal. As we can see that this was in fact the reversal of a trend and hence

the trader would have benefited in this case as well.

Section5.2.2: Moving Average Convergence/Divergence

Figure 20: MACD Buy- Sell signals

The above graph shows the USD-INR movement from April 2010, to January 2011. Now for MACD,

we generally indicators like the crossing of the MACD over the signal line formed by the 9 day

Exponential moving average and the crossing of MACD over the zero line. Around 26 May, 2010 the

MACD crossed over the signal line and if the trader taking a cautious approach waited a little longer

till the MACD crossed the zero line, then he could have bought dollars and sold rupee, and this trade

would have ended positive provided the trader exited his position at reversal using stop loss.

MACD also can give false signals sometimes and this is indicated by the Sell dollar signal generated

around the end of July, 2010. The trader hence has to use stop loss effectively while dealing with

MACD as a momentum indicator. Going ahead if we see that around the end of August, a definitive

sell dollar signal was generated and a trader who would have used this would have benefited

immensely as rupee appreciated from Rs. 46.60 to about Rs.44.085.


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Section 5.3: Trend Based

Section 5.3.1: Moving averagesNote: The signals for BUY and SELL as explained below is to BUY/SELL the Dollar

Market TypeIt is not recommended to trade only according to the moving averages movements and without

using any other indicator. A MA indicator works bestfor a Trending Market and they perform very

poorly especially in the Ranging Market where market gets choppy and trade sideways for a

period of time.

How to Use MA

As already stated, the MA indicator is used in conjunction with other techniques. Based on thisconcept, there are few popular variations in the market that are listed below:

Use of Single / Double/ Triple Averages

Single MA: The moving average is plotted on the bar chart in its appropriate trading day along with

that days rate action. When the closing rate moves above the moving average, a BUY signal is

generated. A SELL signal is given when rate move below the moving average. Generally used

averages are over 5/10 day period (short term) and over 50 day period (long term).

Figure 21: Long term Moving Average Trend


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The above chart shows the trade off between a long term & a short term moving average. While a

short term MA captures the trend quickly (Oval box in the chart), it does by losing out on the

reliability (Rectangle box in the chart)

Double MA: Two moving averages are plotted on the bar chart one short and one long.

Figure 22: Double Moving Average trend

A BUY signal is produced when the shorter average crosses above the longer one while a SELL signal

is produced when the shorter average crosses below the longer one. Hence this is also called as

Double Crossover Method.

Triple MA:An extension of Double MA method, here three MAs are plotted on the chart short,

medium and long trend. The triple crossover method that is used ensures more reliable buy/sell

signal. These three moving averages make an indicator with each other known asAlligator.


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A strong BUY signal is produced when the short term trend (green signal in the chart) crosses above

both medium (red signal in the chart) and long term (blue signal in the chart) trend (Shown circled in

the left oval). While a weak BUY signal is produced in case it crosses only medium term but not the

long term. The SELL signal also follows the same pattern, difference being that the crossing of theshort term is below and not above (shown circled in the right oval). Double & Triple MA are

especially helpful in avoiding wrong signals in ranging markets.

Moving Average EnvelopesIn a MA Envelope, the usefulness of a single moving average can be enhanced by surrounding it with

envelopes. Generally a fixed percentage is used for creating the boundaries of the envelope. In case

of short term trend, 3% envelope is typically used while in case of longer trends 5% envelope is

typically used.

Figure 23: Triple Moving Average trend


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Figure 24: MA envelope

The envelopes produce a warning signal to the traders in case the prices overextend in either

direction from the moving average line. The Two Red Arrows in the above chart are the warning

signal and indicate the traders to sell/buy. The envelope gives indication of volatility, though it is not

as good as Bollinger Bands.

Bollinger BandsTwo trading bands are placed around a moving average similar to the envelope technique. Except

that Bollinger Bands are placed two standard deviations above and below the moving average,

which is usually 20 days. The Bollinger Band produces two kinds of signals on overextension of

prices-

Overbought: When the prices touch the upper band. Oversold: When the prices touch the lower band.


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Figure 25: Bollinger Bands

The Bollinger Bands in the above chart display the Oversold & Overbought positions. At the same

time these bands also give a measure of the volatility. The length of the LEFT BOX is far higher than

the length of the RIGHT BOX. Since the band range is dependent on the standard deviation, it can be

fairly deduced that the market was highly volatile in Nov10 as compared to Jun11. Generally in a

trending market, when the price crosses below the middle band, the target price is the lower band

limit while if the price crosses above the middle band then the target price becomes the upper band

limit.

Pros & Cons of using Moving AveragesOne of the great advantages of using moving averages is that they trade in the direction of the trend.

It provides specific buy and sell signals based to the traders. But as already mentioned they work

best when market is following a trend & perform very poorly in a choppy market.

The fact that they do not work that well for significant periods of time, however, is one very

compelling reason why it is dangerous to rely too heavily on the moving average technique. Hence

the Moving Average Analysis typically is complemented with these tools

Oscillators Elliott Wave Theory Market Sentiment Analysis

Overbought Position


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Section 5.4: Chart Based

Section 5.4.1: Candlesticks

Figure 26: 3 month daily candle stick chart with a 5-day moving averageThe above chart traces the 3 month daily exchange rates with the red line plotting the 5 day moving

averages. The data was procured for 3 months from 20th March 2011 to 20th June 2011. We have

identified a few patterns and tried to explain the trend in the movement of the exchange rates using

them.

Engulfing:

This pattern consists of two candles as shown encircled in a rectangle in the above chart. The first

day is a narrow range candle that closes down up the day. The buyers are still in control but because

it is a narrow range candle, the buyers are not very aggressive. The second day is a wide range

candle that "engulfs" the body of the first candle and closes near the bottom of the range. The

sellers hold an upper hand here. Sellers now are ready to take control. Engulfing is a reversal

pattern. We see from the chart that the rally (or a depreciation of the Rupee) has been pulled back

although for a short period of time.

Dark Cloud Cover:

This is a two day reversal pattern that has bearish implications. The first day of this pattern is a long

white candlestick. This reflects the current trend of the market and helps confirm the uptrend (or

rupee depreciation) to traders. The next day opens above the high rate of the previous day.

However, trading for the rest of the day is lower with a closing rate at least below the midpoint ofthe body of the first day. This is a significant blow to the bullish mentality and will force many to exit


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the market. Thus, those traders who were in long dollar position expecting rupee to depreciate, will

lose out when the rupee starts to appreciate on the second day. Since the closing rate is below the

opening rate on the second day, the body is black. The traders identify this pattern as a reversal

pattern and will try to move out of the position to cut their losses.

Shooting Star:

It is a single day pattern that appears in an uptrend, as seen in the above chart. It indicates that the

uptrend is about to end and may reverse to a downtrend or move sideways. It has opened high,

traded much higher, with the high for the day being much higher, but closes lower than its opening

rate.

The Lower Shadow of the Shooting Star should be close to zero. The Upper Shadow of the Shooting

Star should be as large as possible. The larger the Upper Shadow, the more important is the Shooting

Star. As this occurred in an uptrend the selling pressure is seen as a potential reversal sign. When

encountering this pattern traders will look for a lower open on the next period before considering

the pattern valid and potentially including it in their trading strategy.

Three Black Crows:

It is a bearish reversal pattern consisting of three consecutive long black bodies where each day

closes at or near its low and opens within the body of the previous day. It is used to predict the

reversal of the current uptrend. The reversal pattern should be confirmed with other indicators. We

see here that there is a clear reversal in the uptrend (or the depreciation of the Rupee). The Rupee

then starts to appreciate from about 45.2 to 44.7.

Morning Star:

It is a 3-day reversal candle pattern consisting of three candlesticks - a long-bodied black candleextending the current downtrend, a short middle candle that gapped down on the open, and a long-

bodied white candle that closed above the midpoint of the body of the first day. On the above chart

it is seen that the uptrend has just started, or the Rupee has just started to weaken following a

period of strengthening. Thus, this can give a signal to traders to stock up dollars and sell it later as

the rupee is expected to depreciate.

Harami:

This is again a 2-day pattern indicating a reversal in trend. On the first day there is a wide range

candle that closes below its opening value. The sellers are still in control of this stock. Then on the

second day, there is only a narrow range candle that closes up for the day. The second day candle is

completely within the first days candle.


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Section 6: Technical Analysis: Advantages & Disadvantages

Advantages: Technical Analysis allows the prediction of the future prices/rates of securities/currencies. Technical Analysis focuses on what is the present happenings rather than emphasising on

the historical information.

Pure technical analysis concentrates on the prices, utilising objective tools and disregardsfactors like emotions.

The signalling indicators sometimes point to the imminent end of a trend before it shows upin the actual market. This enables the trader to maintain profits or minimise losses.

Disadvantages: Some critics claim that Dows approach is quite weak since todays prices do not necessarily

project future prices.

Any wide fluctuation in the exchange rate market is corrected by the RBI. If a trade is basedon technical analysis, one is not able to account for the RBI interventions which might work

contrary to the expectations of the trader. Thus the intervention by RBI might completely

negate the direction of the trade based on the analysis charts.

The critics claim that the signal for the change in trend appear too late, often after thechange has taken place. Therefore traders who rely on technical analysis react late and

hence lose about 1/3 of the fluctuations.

Analysis made in the short term may be exposed to noise and may result in the misreadingof market directions.

The methods under technical analysis have been widely publicized over the decades. Manytraders are quite familiar with these patterns and often act on them in concern. This creates

a self-fulfilling prophecy, as waves of buying and selling are cr eated in response to bullish

or bearish patterns.


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Section 7: How traders and dealers use Technical Analysis?

As already explained before, traders can use technical analysis to identify trigger points to buy and

sell rupee. Technical Analysis is more of an objective way of trading rather than one based on gut

feeling and hence is more appropriate for traders who generally have a short term horizon. Some

traders are dependent only on a particular technical analysis technique like the Elliot Wave or

Candlestick. But generally, traders use a combination of more than one technique to trade. Not only

this, a section of traders will not use only purely technical analysis tools, but will have an eye on

macroeconomic factors and if these factors are favourable, then they will combine it with technical

analysis to identify the right entry and exit points, upside downside for a trade. Technical analysis

methods do not always work and hence these traders need to operate in a disciplined way with tight

stop losses.

When it comes to dealers who quote USD-INR and other quotes, they can also use technical analysis

to predict the direction of USD-INR movement and put out appropriate quotes based on that. The

dealers may use pure technical or a combination of technical analysis techniques or a combination of

fundamental and technical analysis to determine the quotes to put out. On an intra-day basis, let us

say the dealer was quoting 1 US$: Rs.45.45-45.55 and he is seeing a clear Elliot wave pattern

developing on the downside or RSI index above a value of 70 clearly indicating a sell for the dollar

and buy for the rupee. If he decides not to move his quote then as the rupee appreciates, then

everyone will sell the dollars to this dealer as his quote will be the best and he will be the preferred

dealer for selling dollars to, but no one will be willing to buy from him as the more proactive dealers

who have identified the trend would have started quoting rates like 1 US$: Rs 45.35-45.45 and these

are better quotes for someone wanting to buy dollars. Hence in such a situation by the time the

dealer reacts, he may have already accumulated excess dollars which he may have to offload atlower rates if the rupee continues to appreciate. Similarly, a dealer can also use technical analysis to

quote opening rates at the beginning of the day. Based on what the technical indicators are showing,

whether it is a bullish or bearish pattern, he will quote an appropriate gap-up or gap-down quotes.


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Section 8: Bibliography

Chandra, P. Investment analysis and Prtfolio Management. Murphy, J. J. Technical Analysis of Financial Markets. Shapiro, A. C. Multinational financial Mangement. Weller, C. J. (2011). technical analysis of forex Markets. http://finance.wharton.upenn.edu/ http://www.realtimeforex.com www.ino.com www.forexpros.com www.forextradingcharts.com
http://finance.wharton.upenn.edu/http://finance.wharton.upenn.edu/http://www.realtimeforex.com/http://www.realtimeforex.com/http://www.ino.com/http://www.ino.com/http://www.forexpros.com/http://www.forexpros.com/http://www.forextradingcharts.com/http://www.forextradingcharts.com/http://www.forextradingcharts.com/http://www.forexpros.com/http://www.ino.com/http://www.realtimeforex.com/http://finance.wharton.upenn.edu/

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