Currency prices rarely move in smooth progressions. This is because currency traders, as a group, tend to sell when they think a currency is peaking, and buy when they think it has bottomed out. This creates a zig-zag pattern that partially masks the longer term movement of the currency price. Even if a currency pair is relatively stable, the price will still fluctuate in a wave-like fashion due to the activities of speculators. The greatest profit opportunities are presented when the price breaks out of one of these patterns.
Support and Resistance Levels
In order to reveal the underlying trends in a currency chart, you can draw a line across the lowest troughs, known as the support line, and the highest peaks, known as the resistance line. A breakout is the point at which a currency price rises or falls outside established support and resistance levels. These breakouts can serve as valuable clues to the longer-term movement of a currency price. In order to spot a breakout, you have to measure the volatility in a currency pair. In forex trading there are three main methods that can be used to this end: moving average, Bollinger bands, and average true range (ATR).
A moving average measures the average movement of the market for over specified periods of time. So, if you set it up to give daily averages, and took a sample every hour, the average for each day would be equal to all of those samples added together divided by 24, which is the number of samples. Over the course of a week, you would have seven daily averages, and when this data was presented in the form of a line graph, it would hopefully display the underlying trends a little more clearly than a graph of the raw data for the same period.
Bollinger bands are a technical analysis tool that was invented by the American financial analyst and author John Bollinger in the 1980s. They are basically two lines on an asset price graph, with each line being plotted two standard deviations above and below a moving average line for a certain time period. A standard deviation is the distance between support and resistance lines over a specified length of time. When the lines ore close together on the vertical axis, this is an indicator of low volatility. When the lines are far apart, this is a measure of high volatility.
Average True Range (ATR)
The Average True Range is a great tool for measuring the volatility of an asset, because it tells you what the average trading range of the market is over a specified period of time, rather than the distance between extremes. When it is falling, it means that the volatility of the asset is falling, and when it is rising, it means that volatility is rising.
By using a combination of these tools, you can spot breakouts much more reliably than if you were only looking at graphs of the raw data. However, it should be noted that while graphs showing moving average, Bollinger band, and ATR data can clarify the true movement of a currency price over time to a certain extent, they can also mask it, so when you are looking for breakouts it is best to use these tools in combination with the raw data, rather than as a replacement.