Universal Mathematical Models

The basis of these mathematical models is to incorporated a theory that will then automatically turn out signals as when to buy and sell, and should also serves as confirmation prior to a trade.

A. Moving Averages

The first move from charts towards models usually involves placing moving averages over the chart of the spot price as shown in the example below:

This moving average can be either a simple arithmetical average or an exponential (weighted) average. In the former case, equal weighting is given to all values used in the average, while in the latter; much greater weighting is given to the latest data. This of course means that a weighted moving average will follow the spot price more closely than the arithmetical average.

The assumption that price movements in the FOREX market is volatile and that a trend will remain in place long enough to benefit from allows moving averages to smooth out irregular price fluctuations.

The basic principle is that a short run moving average crossing a longer term moving average on the way up indicates a change in sentiment and suggest a “buy”. A downward crossing of averages conversely represents a “sell”.

Most moving average models tend to work best in a strongly trending market. A relatively trendless market only leads to the possibility of “whipsaw” patterns with no genuine trade opportunities.

B. Momentum

Momentum is the rate at which a price changes, and is usually used to look for overbought or oversold levels. This change in momentum can be understood by angles, meaning the sharper the incline or decline, the greater the momentum in that direction. And it is reasonable to suppose that when momentum has reached excessive proportions, a pullback or period of consolidation might be expected. Similarly, although an exchange rate may still be rising, its rate of advance may be declining, perhaps giving an early warning of a change in trend.

Momentum should not be used alone, a rising or falling momentum index indicates very little, but when used in conjunction with a moving average provides good indications of buying or selling pressures.

Note: The greater the momentum within a market the more volatility is present. With more market volatility, the sharper the angle of momentum to one side. And the sharper the angle of momentum the less sustained that trend becomes.

C. Relative Strength Index

RSI is usually used to detect overbought and oversold conditions gauging the strength of market trends and serves as confirmation to chart formations (see Indicative Trend Setting Chart Patterns). There are two important levels, 70 and 30. The 70’s level represents overbought conditions within the market place and expects the market to retrace shortly offsetting any buying pressure. The same is true of level 30’s, where market conditions are considered oversold and a offsetting of selling pressure is imminent.

D. Fibonnacci

This is a measure of market retracements of current trends, and is usually applied to hourly and daily charts. There are 3 major levels of retracements based on this model, and they are 33%, 50% and 66%. The idea is that once prices start to retrace, these levels serve as support or resistance (depending on trend), and is a level in which prices should hold well. Given that the 33% level is broken then the next level at 50% should hold better, and so on till the 66% level. Beyond this, market direction is said to have reversed.

The most important level in Fibonnacci is the 50% retracement level, in that most trends will either hold its original trend direction or change if broken.

Conclusion

Technical Analysis has become a very important part of the FOREX market, with many market participants actively watching, opportunities to profit are always at hand. Equipped with the right tools and mindset, they position themselves within a marketplace among diligent investors who take part in actively shaping their own financial future.