“Technical analysis may appear complicated on the surface, but it boils down to an analysis of supply and demand in the market to determine where the price trend is headed.” — Investopedia
Technical Analysis the study of the markets action, a school of thought, a particular way of thinking, strategizing that starts with charts that shows price and trading volume history. It looks at the price movement of a company and uses its information and data to predict the future price movements.
Based on Three Presumptions:
- They discard the need for fundamentals based on Efficient Market Hypothesis (EMH);
- Price moves in Trends;
- History repeats Itself;
Users do not believe there’s a reason to study a company’s statements, as fundamental analysis do, since the stock price or market cap already includes all relevant information. Instead they focus on analyzing the chart itself for clues into where the price may be headed.
It has a fast approach prediction and conclusion usually in weeks, days even hours or minutes. As in opposed to Fundamental Analysis that could take years.
The main goal is to identify short to medium term trades where they will be able to take advantage of the market and trade successfully.
Technical Analysis uses historical price and volume to attempt predictions, based on human psychology.
Human behavior in the market creates a pattern and has been used for hundreds of years in Japan, where this technique first started.
Japan has used this technique since 1600’s when a guy named Hamna started with this analysis to identify trends or patterns in human behavior while trading rice. And it only became popular in the Americas in the 1970’s.
Sure, enough Hamna became very successful in his industry, tracking human behavior to identify if there isFear (awareness of danger) or Greed (Excessive desire) in the market. Keeping the users of this technique ahead in the game, knowing when to buy or drop-out.
Critics of the Technical Analysis view this technique as unproven as a game of luck. Even though the strategy has proven itself for hundreds of years.
Human Psychology has remained as trackable as always, because we react in masses, it doesn’t
matter the market, human behavior still gives away patterns and that will never change.
Chart Patterns establish definition and criteria.
There are two major patterns to look for when identifying price patterns using trendlines: Reversing patterns and continuation patterns.
Reversal patterns suggests that a prior trend will reverse upon completion of the pattern. Reversals indicates that a trend will change in direction which can be good or bad against prevailing trend. There are several different reversal patterns you can study: Spike, Double Tops and Bottoms, Triple Tops and Bottoms, Head and Shoulders, Inverse Head and Shoulders.
Continuation patterns suggests that a trend will continue even once the pattern is complete. There are several ways to identify continuation patterns you can study: triangles, pennants, flags, rectangles.
A trendline is a line drawn over pivot highs and under pivots lows to show prevailing direction of the price. Trendlines show support and resistance in the time frame.
They also show direction and speed of price describing patterns during price contraction or decline in a business cycle.
Business cycle is composed of expansion, peak, contraction and trough.
Expansion: when business cycle moves from trough to peak;
Peak: highest end between an expansion and the start of a contraction;
Trough: marks the ending period of a declining and the transition to an expansion;
Contraction: is when the economy as whole is in decline.
Identifying the trend is the first step in the process of making a good trade. Trendlines first identify and then confirms a trend or a pattern.
Three Types of Charts used.
1. Candlestick Chart (Most Popular)
Candlestick charts shows Open Price, The High Price, The Low Price and Closing Price, in a given time you get to choose, for example 1 minute, 5 minutes, 1 hour, 1 day, 1 month or 1 year.
When candlestick is green it indicates that the closing price was higher than the opening price within given period. When candlestick is red it indicates that the closing price was lower than the opening price within time given.
The wicks illustrate the highest and the lowest prices within a period of time.
Candlestick charts could be green & red or black & white.
2. Bar Chart
Shows Open Price, Closing Price, High Price, and Low Price, also within time given as seen with candlestick chart.
Vertical lines representing price range for a given period, with smaller horizontal dashes on each side representing open and closing prices. Dash on the left represents opening price, dash on the rightrepresents closing price.
When opening price is lower than closing price the bar is shaded green orblack, which means price grew within given period. And when opening price is higher than closing price, the bar is shaded red, which means price went down within given period.
3. Line Chart (Least Used)
It does not provide the information provided by the others. It is a simple chart.
Line Charts are used to visualize a trend in data over intervals of time. In this case, same as the others but in a simple flow that connects closing price values (the dots) with a line.
There are many types of charts, these are just three which you might see most.
RSI — RELATIVE STRENGTH INDEX
Is a momentum indicator used in TA.
Compares the magnitude of recent gains and losses on a specific time, measuring speed + price changes.
Mostly used to identify overbought or oversold conditions of a market or asset.
Measuring values from 0–100 with a time frame of 14 trading days.
Values of 70 or more are considered overbought of becoming overvalued. Readings of 30 and below, is interpreted as indicating an oversold (overvalued) suggesting a trend change or an upside reversal.
Some traders to avoid falling for RSI false signals, they rely on extremes, focusing when it values above 80 indicating overbought or below 20 signaling oversold.
Technical Analysis is complex to say the least, we understand now that it relies on the belief that studying the prices on the charts alone is seen as enough (in TA), to understand where a particular market may be headed.
They believe the prices on the chart already shows everything it needs to show in order to come to a conclusion about the future of the security or commodity in question. There are several available indicators for TA and in this post, we were able to go over only some, but very relevant giving us a basic understanding of what TA is, and hopefully giving you a good base to continue your studies.
And to end with a tip: Pairing up Technical Analysis with Fundamental Analysis may be a good idea for some.