What is Technical Analysis?
When I explained what a Trading Strategy is based on in the Trading Basics series, I emphasised the three principles of Technical Analysis – do you remember them? They are:
- Market action (price) discounts everything
- Prices move in trends
- History repeats itself
It’s important to keep those principles in mind throughout the entire series of Technical Analysis basics.
We already know that Technical Analysis is the study of market action, primarily through price charts, in order to identify the next trend as early as possible. Identifying trends as early as possible gives the trader the opportunity to “ride the trend” and take advantage of a potential rally. Traders have a lot of tools to help them in this quest for the trend; these include Support & Resistance, trendlines, Price Patterns, Japanese Candlestick patterns and indicators etc.
For example, employing popular price patterns such as the Head and Shoulders can assist in identifying trends at their earliest stages. Trendlines guide traders to navigate the financial markets like the compass guides the sailor to navigate the open seas. If the price honors the trendline, the prevailing trend should remain intact. If the trendline is “violated”, this is seen as a warning that the prevailing trend may be coming to an end.
Indicators and oscillators are also very popular tools for technical traders, and the MACD is among the most used. When the MACD crosses above the zero line, it signals an uptrend. When it falls below the zero line it signals the beginning of a downward movement.
Traders are advised to combine a variety of tools, rather than taking the much riskier option of relying on a single one. There are many more tools that technical traders use, which you will see throughout the course of the Technical Analysis video series.
Technical analysis is the study of price movement on charts which can determine current and future trading conditions. By following three core principles, traders hope to identify recognisable patterns and use technical indicators to enter and exit trades at the optimum price.
There are two main types of technical analysis – chart patterns and technical indicators. Chart patterns are subjective forms of price action analysis which traders identify from historic price movements, such as a double top/bottom or an ascending triangle. These patterns can be bullish or bearish and continuation or reversal patterns.
Technical indicators apply numerous mathematical calculations to price and other relevant statistics like volumes. There are hundreds of tools and indicators traders use such as Moving Averages, Stochastics and Bollinger Bands.
Technical analysis can be applied to virtually any financial market - forex, indices, stocks, commodities and cryptocurrencies. Chart patterns and technical indicators can be used across any time frame or a combination of time frames. By knowing precisely where to enter and exit trades, traders can establish clear risk management rules and analyse their trading performance in detail. Often, technical analysis can be used in conjunction with other types of analysis like fundamental and sentiment analysis.
The best way to learn technical analysis is to get a solid understanding of the three main principles and then look at the basic rules in action on price charts. This will include support and resistance lines, as well as trendlines. Learn to identify historic patterns and you’re starting to become a technical trader.
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