Greetings, dear readers! Today I would like to talk to you about the technical analysis. Actually, this topic is worth a series of articles. Nevertheless, we will try our best to explain the essence briefly and clearly, along with key analysis and methods of executing it, in order to give the readers the clear recognition of how traders make decisions on entering or quitting the market.
6. Summing up
The core of technical analysis: simple and complicated!
In the article What is Trading: Essence, Pros and Cons, Classifications, 6 Key Trading Tools + 3 Analysis Types!, we have already mentioned what technical analysis is and why we need it.
Technical analysis is the analysis of a certain-asset chart aimed at determining further growth or fall of asset price through using specific instruments. Surely, it’s essential for making a decision on buying or selling an asset. Correct forecasts are the cornerstone for high profits! That’s why, hundreds of tools enabling us to analyze the chart, are developed.
Actually, the word “technical” is not the total truth here. This word causes associations with mechanisms, devices, and equipment. However, technical analysis should have been called “psychological”, “emotional”, “graphic”, or something. Why so? Asset price depends on traders’ psychology (emotions). Alexander Elder wrote about it in his Trading for a Living.
That is probably because there is no perfect chart analysis tool to forecast asset prices with 100% accuracy. Correct use of indicators, strategies, and other analysis tricks provides 70-80% successful deal! However, this accuracy is enough for getting really high profits!
Technical analysis provides for determination of the price direction, change rate, duration of upward or downward movement, its strength, and finding the best point for entering or quitting the market.
The history of technical analysis: away back!
The history of technical analysis stretches back for more than 4 centuries. Its base was founded by Joseph de la Vega. The breakthrough in this field was creation of Japanese candlesticks – the same ones that are still used for chart formation. Homma Munehisa suggested using them way back then, about 200 years ago.
The very first learning literature appeared in the early previous century, thanks to Richard Schabacker, who published Dow and Hamilton’s works. After that, the grand masterpiece of Edwards and Magee. This edition is reprinted even today! Therefore, principles of technical analysis remain the same and do not lose their actuality. Being universal, they are suitable for any asset. Also, Dow’s. Elliott’s, Gann’s, Wyckoff’s works and tractates of other 20th century traders continue to be relevant nowadays.
New chart analysis methods are being developed constantly. Global computerization imparted significant acceleration to this process. For the recent 10 years, hundreds of new trading prediction strategies, means, and methods have appeared.
Three postulates of technical analysis
There are 3 cornerstone axioms each and every trader shall recognize. A brilliant and brief trio of key statements embrace the essence of technical analysis. It’s like a basement giving ground for all forecasting theories and tools.
- Price considers everything!
Technical analysis must be sufficient for efficient asset trading. A trader good in working with specific instruments has no need in grinding fundamental analysis (find more about the latter in the article Fundamental Analysis: TOP 5 Methods to Analyze the Market).
The price is the compromise between a seller and a buyer at a certain moment, which is reached based on the acquired economic, politic, social, and other-nature information. So, one doesn’t have to study news themselves or buy insider knowledge – the chart has all that is needed for profitable trading.
Fundamental analysis facilitates decision-making, confirming or disproving technical analysis data.
One should also realize that a man of mold cannot have access to all information regarding economy of a country or industry. It will be also impossible to learn underhand dealings that usually take place in major corporations and can affect prices of securities or currencies.
- Price movement delivers the trend
Thoroughly analyzing charts, one may infer that sometimes, certain trends (upward or downward ones) can be seen in the market. They do appear only in 30-40% cases. Trends are good in that they enable traders to gain pretty much.
If demand increases supply, an upward trend is formed. The market in such case is called “bullish”. And conversely, if demand is lower than supply, a downward trend emerges, i.e. the price continuously falls with insignificant adjustments over a period. Such market is called “bearish”. When bulls and bears are equal in power (demand counterbalances supply), then the market is flat (it is commonly called sideways movement or consolidation).
- History repeats itself!
Cycles are typical not only for history, but price movement as well. As I’ve mentioned, the rate heavily depends on psychology. It was proven years ago that a group of people is supposed to behave in the same way in similar situations. Due to this fact, technical analysis widely applies graphic models (shapes, patterns).
4 key chart types!
A chart is the illustration of a bulk of data. In our very case, it depicts the cost of assets (or trade volume). In fact, 80% of information is perceived by human through eyes. It’s way easier to assimilate pictures, tables, diagrams, as well as to analyze them. You must agree it is by far simpler to assess the market situation in the chart rather than using long, long columns of numbers.
At the moment, the main weapon of any trader is the trading terminal (trading platform), i.e. the special software enabling to get access to an exchange, reflecting current quotes of hundreds of assets, containing numerous analysis tools and information regarding a trader and their trading deposit. Such a program is provided by the broker when contracting. MetaTrader is one of the most popular trading platforms today.
Learn more >>> MetaTrader as the Deep Analysis Tool!
The only exception is binary options brokers. They provide no exchange entrance, so there is no need in any special software or contracts. All one needs is to register on the company’s website and then get access to the trading terminal. Bintrader is the leading binary options broker now.
Such terminals may have several chart types:
They are linear charts that everybody knows from school. The X-axis is for action time, while the Y-axis depicts the asset price. A point is drawn at the intersection of price and time, and all points are connected into a single line. Oscillations of this line provide for evaluating the market state, asset volatility, availability of a trend or a flat, etc.
Bars are chart elements. One bar reflects the price range which and asset was traded within during a period (for instance, during 5 minutes). Here is how a bar looks like.
It may enable to see the range, price extremums: minimums and maximums, open and close prices. The bar-made chart gives more information than the linear one. Here’s how it looks like in a trading terminal.
- Japanese candlesticks
The basement of the Japanese candlesticks method is analogical to the previous one. I mean, a candlestick depicts the price minimum and maximum, period open and close. The difference in better visualization as compared to bars – therefore, it’s preferred by the absolute majority of traders throughout the world. A Japanese candlestick looks like as follows:
If the asset price rose, open price is at the bottom, while close price is on the top. If the price fell, then the open price is on the top, and the close price is at the bottom. Colors of Japanese candlesticks may be different. The most illustrative ones are green and red. Green signalizes about growth, and red reports on price lowering.
Such a type chart is way too simple. It’s totally same to linear charts. The only difference is that the area underneath the line is colored.
TOP 8 Chart analysis methods
Now, when we have figured out the basics, let’s come to the analysis itself. We are to look into 8 best technical analysis methods used by traders all over the world – from simpler to tougher.
Support and resistance levels
Support and resistance lines are the all-purpose tool depicting psychological barriers of traders. Support shows the lowest possible level of a price; resistance reflects the level that the price is not supposed to exceed. It doesn’t mean that, having come to such a corridor, the price won’t be able to leave it at all. However, certain circumstances are required to drive the price off the area. It can be an economical news to affect the price of a currency.
It’s convenient to use support/resistance while trading binary options, because s a trader knows how the price will move. This means that if the price reaches the support level, bounces off it and jumps, then touching the resistance line, it will turn around and start falling.
Without hyperbolizing, trends are essential for traders’ living. Market entrance in the beginning of a strong trend and quitting market at the full end provides the highest possible profit. Trends can be short-term (day), middle-term (month), or long-term (year). Terms are by far shorter in binary options: 5-15 minutes, 1-4 hours, and 1 day.
In order to determine a trend, one should draw a line on two consequent extremums. If a local maximum is higher than the next local maximum, then we probably speak of a downward trend.
If the local minimum is lower than the next price minimum, this means we have an upward trend in the market.
Surely, having determined the trend nature, one should follow it. If a trend grows, then we need to buy, and if a trend falls, we need to sell. If a trendline is breached, then a reversal is likely to take place soon.
It’s essential to determine the time of entering/quitting the market correctly. Hundreds of analysis tools are used for that. Among graphical methods, shapes appearing in the chart hold a specific place. We speak of specific hints enabling experienced traders to recognize further price direction. The most widespread and efficient are:
- Head and shoulders,
- Double top.
Each shape stands for a trend reversal. They are particularly efficient when working with high-volatility assets, on the 15-minute or larger timeframes. One is not supposed to look for shapes in the chart of a low-volatility asset. Efficiency of shapes proves the third postulate of technical analysis: history repeats itself!
A moving average is a line calculated using the average formula and drawn in the chart. It’s usually used for mitigating market noise in order to assess the market situation without being distracted by insignificant adjustments and pullbacks. It enables to determine the trend. Besides, moving averages are used as an element of many trading strategies – we are to cover this issue a bit later.
There are lots of types of moving averages depending on the calculation formula, but if one puts them all into the chart, then it will be clear they are quite similar to each other. The only difference is that some of them are faster than others. A simple, exponential, and weighted moving averages are included in the standard toolset of any trading terminal.
An indicator in technical analysis is an analysis tool based on the math model (formula). Usually, such formulas consider the price and trade volume within a certain period. Most beginner traders make a huge mistake fully relying on indicators’ data instead of learning fundamentals of the graphic analysis (trends, support/resistance, shapes, patterns, etc.).
Trading gurus use indicators only for confirmation of their conclusions. Why so? In fact, their lines are drawn based on data that have already gone the way of the dodo! This means that signals of indicators are late.
The hottest are:
- iVAR – indicates presence of a trend/flat;
- ATR – used to measure volatility of currency pairs;
- HL – draws support and resistance lines, as well as price canals;
- Ravi – a great trend indicator;
- RSIOMA – based on RSI and МА;
- Bollinger Bands.
They were just several examples. In your trading terminal, you will find numerous use-anywhere indicators, but before using a one, please make sure you properly interpret signals of this very analysis tool.
Oscillators are also indicators. Their definitive feature lies in the fact that they can shift events and then forecast the market situation quite accurately. Usually, they don’t draw prices in the chart and called “non-drawing indicators”. Lines of the tool are drawn lower than the main chart, which is rather convenient.
It’s commonly assumed that they are best for using when a consolidation emerges in the market, and to forecast a reversal. Late indicators, however, show higher efficiency in case of a trend. The most popular oscillators are Stochastic and RSI. They are applied as a whole-value analysis tool, or a strategy element.
Indices are coefficients reflecting prices of securities used for its calculation. They are required for fast evaluation of trading session results. For better visualization, charts are also built on them. Each country has its own index. The most popular indices are:
- Dow Jones – calculated based on the value of stocks of 30+ American companies for almost 120 years;
- FT-30 – based on data of 30 major British companies;
- Nikkey – originated in Japan, it’s calculated based on the value of stocks of 10 largest companies;
- RTS – the most significant exchange index of Russia.
Just like litmus paper, indices quickly and accurately depict the country economy at large!
A trading strategy is the algorithm of trader’s actions aimed at getting stable result by using a one or several analysis tools. One can either create their own algorithm, or use ones developed by professionals and proven by dozens of years of successful trading. Trading strategies are not universal – they must be selected particularly for each type of exchange, trading asset, or even a timeframe!
Technical analysis involves numerous tools that provide accurate forecasting of further price behavior. However, one ought to remember that never a one tool is capable of giving 100% accuracy and correctness, so the main thing of technical analysis is knowledge and experience of a trader. Good luck!