Intro to Tech Analysis
Technical analysis is a method of forecasting price movements by
looking at purely market-generated data. Price data from a particular market
is most commonly the type of information analyzed by a technician, though most
will also keep a close watch on volume and open interest in futures contracts.
The bottom line when utilizing any type of analytical method, technical or otherwise,
is to stick to the basics, which are methodologies with a proven track record
over a long period. After finding a trading system that works for you, the
more esoteric fields of study can then be incorporated into your trading toolbox.
Almost
every trader uses some form of technical analysis. Even
the most reverent follower of market fundamentals is likely to glance at price
charts before executing a trade. At their most basic level, these charts help traders
determine ideal entry and exit points for a trade. They provide a visual
representation of the historical price action of whatever is being studied. As
such, traders can look at a chart and know if they are buying at a fair price
(based on the price history of a particular market), selling at a cyclical top
or perhaps throwing their capital into a choppy, sideways market. These are just
a few market conditions that charts identify for a trader. Depending on their
level of sophistication, charts can also help much more advanced studies of the
markets.
On the surface, it might appear that technicians ignore
the fundamentals of the market while surrounding themselves with charts and data
tables. However, a technical trader will tell you that all of the fundamentals
are already represented in the price. They are not so much concerned that a natural
disaster or an awful inflation number caused a recent spike in prices as
much as how that price action fits into a pattern or trend. And much more to the
point, how that pattern can be used to predict future prices.
Technical analysis assumes that:
The
building blocks of any technical analysis system include
price charts, volume charts, and a host of other mathematical representations
of market patterns and behaviors. Most often called studies, these mathematical
manipulations of various types of market data are used to determine the strength
and sustainability of a particular trend. So, rather than simply relying on
price charts to forecast future market values, technicians will also use a variety
of other technical tools before entering a trade.
As in all other aspects of trading, be very disciplined when using technical analysis. Too often, a trader will fail to sell or buy into a market even after it has reached
a price that his or her technical studies identified as an entry or exit point.
This is because it is hard to screen out the fundamental realities that led
to the price movement in the first place.
As an example, let's assume
you are long USD vs. euro and have established your stop/loss 30 pips away
from your entry point. However, if some unforeseen factor is responsible for pushing
the USD through your stop/loss level you might be inclined to hold this
position just a bit longer in the hopes that it turns back into a winner. It is
very hard to make the decision to cut your losses and even harder to resist the
temptation to book profits too early on a winning trade. This is called leaving
money on the table. A common mistake is to ride a loser too long in the hopes
it comes back and to cut a winner way too early. If you use technical analysis
to establish entry and exit levels, be very disciplined in following through
on your original trading plan.
Price charts
Chart patterns
There are a variety of charts that show price action. The most common are bar
charts. Each bar will represent one period of time and that period can be anything
from one minute to one month to several years. These charts will show distinct
price patterns that develop over time.
Candlestick patterns
Like bar charts patterns, candlestick patterns can be used to forecast the
market. Because of their colored bodies, candlesticks provide greater visual detail
in their chart patterns than bar charts.
Point & figure patterns
Point and figure patterns are essentially the same patterns found in bar charts
but Xs and Os are used to market changes in price direction. In addition,
point and figure charts make no use of time scales to indicate the particular day
associated with certain price action.
Technical Indicators
Here are a few of the more common types of indicators used in technical
analysis:
Trend indicators
Trend is a term used to describe the persistence of price movement in one direction
over time. Trends move in three directions: up, down and sideways. Trend
indicators smooth variable price data to create a composite of market direction.
(Example: Moving Averages, Trend lines)
Strength indicators
Market strength describes the intensity of market opinion with reference to
a price by examining the market positions taken by various market participants.
Volume or open interest is the basic ingredients of this indicator. Their signals
are coincident or leading the market. (Example: Volume)
Volatility indicators
Volatility is a general term used to describe the magnitude, or size, of day-to-day
price fluctuations independent of their direction. Generally, changes
in volatility tend to lead changes in prices. (Example: Bollinger Bands)
Cycle indicators
A cycle is a term to indicate repeating patterns of market movement, specific
to recurrent events, such as seasons, elections, etc. Many markets have a tendency
to move in cyclical patterns. Cycle indicators determine the timing of a
particular market patterns. (Example: Elliott Wave)
Support/resistance indicators
Support and resistance describes the price levels where markets repeatedly
rise or fall and then reverse. This phenomenon is attributed to basic supply and
demand. (Example: Trend Lines)
Momentum indicators
Momentum is a general term used to describe the speed at which prices move
over a given time period. Momentum indicators determine the strength or weakness
of a trend as it progresses over time. Momentum is highest at the beginning of
a trend and lowest at trend turning points. Any divergence of directions in price
and momentum is a warning of weakness; if price extremes occur with weak momentum,
it signals an end of movement in that direction. If momentum is trending
strongly and prices are flat, it signals a potential change in price direction.
(Example: Stochastic, MACD, RSI)
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