Forex Q&A

A “short-squeeze” is a bullish scenario where a high percentage of traders are short in a currency pair when the market begins to move against them (by rising).

Since most traders use stop-loss entry orders to limit losses or will close out positions if they move against them too much short squeezes can accelerate as stops are tripped to cover losses. Also since most of the traders are already short their selling power may be limited as the pair moves against them, further accelerating the bullish move. For example, lets say 80% of speculative traders are short the AUD/USD pair. If the pair starts moving upward on heavy bank buying then two things happen: a) traders are unable to sell  further as they are already short, and b) as their stop-loss orders get tripped the pair will accelerate upward.

Also see long squeeze.

RSI or Relative Strength Index is an oscillator that uses the change from one closing price to the next to tell you when a pair is oversold or overbought. Default ranges between 0 and 100, with a value less than 30 generally meaning “highly oversold” and more than 70 meaning “highly overbought”, though some traders use 20 and 80.

Like most oscillators the RSI is most-valuable in range-bound markets and least-valuable in trending markets.

A “range” is an area between support and resistance where a pair’s price action is confined.

For example if the EUR/USD is said to be “ranging between 1.4000-1.4100″ then 1.4000 is pair support and 1.4100 is resistance and the pair is expected to remain between these areas for the time being. Many traders develop specific trading strategies for range-bound markets. Oscillators such as RSI and stochastics are also most-valuable in ranging markets.

A “rally” is the opposite of a dip and means when a pair rises on the charts (increasing the exchange rate). Traders frequently wait for rallies to sell in downtrend markets or in oversold markets. This is also called “fading the rally” or “selling the rally”.

The pound is the British unit of currency (GBP). Also known as cable.

A “pip” the smallest amount by which a currency pair can change (though many brokers now offer fractional pips). Usually equivalent to $0.0001 for US dollar-related pairs. So for example if the EUR/USD goes from 1.4000 to 1.4015 that is a bullish change of 15 pips.

“Oversold” is a market condition when a pair has been heavily sold and the pair has subsequently dropped quite a bit.

Many traders will look to go long in an oversold market as they believe other traders will have to go long to cover their shorts and take profit, driving the price up.  Most frequently “oversold” conditions are detected with an oscillator.

“Over-bought” is a market condition when a pair has been heavily bought and has subsequently risen quite a bit.

Many traders will look to go short in an overbought market as they believe other traders will have to go short to cover their longs and take profit, driving the price down.  Most frequently “overbought” conditions are detected with an oscillator such as RSI or Stochastics.

An oscillator is a type of technical indicator that typically “oscillates” between 0 and 100 and lets traders know when a pair is oversold or overbought.

For example the RSI, or Relative Strength Index, uses the change from one closing price to the next to tell you when a pair is oversold or overbought. Other common oscillators are the stochastic and parabolic SAR though there are many, many more. Oscillators are generally considered leading indicators and are better served in range-bound markets, not trending markets.

A “long squeeze” is a bearish scenario where a high percentage of traders are long in a currency pair when the market begins to move against them.

Since most traders use stop-loss entry orders to limit losses or will close out positions if they move against them too much long squeezes can accelerate as stops are tripped to cover losses. Also since most of the traders are already long their buying power may be limited as the pair moves against them, further accelerating the bearish move. For example, lets say 80% of speculative traders are long the EUR/USD pair. If the pair starts moving downward on heavy bank selling then two things happen: a) traders are unable to buy further as they are already long, and b) as their stop-loss orders get tripped the pair will accelerate downward.

Also see short squeeze.