We’re glad to present this technical analysis guide. As you go through it, you will learn the basic assumptions of technical analysis, common misconceptions, and several other details that will help you increase your profit potential as you trade on securities.
Many times trading newbies don’t know how to approach trading, they jump into it, and when they burn their fingers, they give up and dismiss it as another “gamble.”
Technical analysis allows you to look at past trading, study the price movements, and use chart patterns and indicators to predict future trends.
It’s about comparing the past and present performance of a security and using the information to inform future trends before entering the market.
In This Guide
What’s Technical Analysis?
Technical analysis is a system of forecasting the future prices of an asset through the study of past price behaviour. You evaluate securities by analyzing past prices, volume, and other statistics generated by market activity.
As a technical analyst, you don’t measure the intrinsic value but rather use charts and other tools to identify patterns suggesting future activity. In other words, it is a data-driven way of analysing financial instruments.
Technical analysis involves the study of demand and supply to determine the trend that will continue in the future. With this kind of analysis, you study the market itself to understand its emotions.
Understanding technical analysis benefits and limitations will give you a set of skills/tools to be a better investor.
Technical analysis looks at a security’s price movement, which will tell you how its future price movement will be. This form of analysis can be used on any security with historical trading data, including stocks, forex, commodities, future, etc.
The Principles Of Technical Analysis
Technical analysis is based on 3 main assumptions, otherwise known as principles; the market discounts everything, price moves in trends, and history repeats itself.
Principle 1: The Market Discounts Everything
Technical analysis is only focused on price movement and does not involve the fundamental factors of the company. But technical analysts assume that stock prices at any given point in time reflect all that could affect the company.
Technical analysts posit that the fundamentals of the company, the market psychology, and the broader economic factors are priced into the stock. Therefore, you’ve to look at them as a unit and not separately. Thus to the analysts, the price movement is a product or demand and supply of a particular security in the market.
The overriding principle here is that all that happened, happening, and could happen is factored and thus, no unknown information to the price. Hence you look at the past and present behaviour and make a relatively accurate prediction of the potential future direction.
Principle 2: The Price Moves In Trends
In technical analysis terms, a trend is where something moves to, and you can see it when the short-term volatility noise is removed. Technical analysts use that behaviour to guess when the trend will happen, the longer they could last to find the entry and exit points.
Upon establishing the trend, the price movement is likely to be in the same direction as the trend and not against it. Many technical trading strategies are based on this assumption.
Principle 3: History Tends To Repeat Itself
The assumption here is that “if it happened in the past, it could happen anytime” Investors have repetitive behaviour. Their past trading behaviour is likely to reoccur thus, as a trader, you can predict what’s going to happen. Simply put, market participants tend to react similarly to stimuli over time.
Here, chart patterns are used in analyzing market movements and understanding trends. Though most of these charts have been used for more than a century, technical analysts still believe they are relevant.
Basics Of Technical Analysis
The common language in technical analysis is the language of charts, and therefore we look at the tools used. Many years ago, looking at a line chart, you’d see a single price represented like the closing price of a particular asset in a day.
At that time, much information was missing from the charts, which posed a challenge when making decisions. That led to the adoption of another tool – the Japanese candlesticks.
Japanese Candlestick
What’s Japanese Candlestick?
This is a price chart showing the opening, closing, high and low points for a particular trading period. Some centuries ago, the Japanese rice merchants came up with this chart and later popularised it by the famous broker Steve Nison in the ’90s.
Japanese candlesticks are popular for analysing price action, especially with technical traders. The information in these charts is more visual than the traditional line charts.
Candlesticks are the presence of most of the traders because they are easier to analyse compared to others.
Technical traders track previous movements using candlesticks patterns to get clues on the direction of the market. They do use recognisable shapes.
Support and Resistance Levels
These are price levels where reversals can potentially happen.
This is how it works; after the price moves up and pulls back, the highest point is reached before pulling back is Resistance. The Resistance level will tell you where there’s a surplus of sellers.
When the price moves up again, the lowest point before starting back is now Support.
The Support levels show where there’s likely to be a surplus of buyers. That way, Support, and Resistance are formed as the price moves up and down over time.
An asset’s price tends to stop falling at Support, and Resistance is where the price stops rising.
How Do You Use Support And Resistance Effectively?
You need to understand how asset prices typically move and then interpret Support and Resistance from that point.
You also have to know that there are different types of Resistance and Support; major and minor.
Minor levels can easily be broken while the major/strong ones are likely to hold and move in the other direction.
Trends and Charts
The versatility of technical analysis makes it unique. The principles are universally acceptable and applicable, and you can use the same theoretical background to perform all the steps in the analysis.
You don’t need training in Economics to understand a market chart. You can apply the technical principles of Resistance, Support, trading range, and others to any chart.
That sounds easy, but technical analysis is not a walk in the park. You must have a solid strategy, keep your head cool, and dedication.
Advantages Of Technical Analysis
- Technical analysis, to some extent, relies on fundamental data. You’ve economic indicators like inflation, job numbers, trade data, etc., that are released daily across the world. For the technical analyst, every piece of news has been incorporated into the market’s activity.
Thus you don’t have to wait for the release of any data monthly or quarterly. All you have to do is to observe the technical analysis movement, then jump into the market.
- Technical analysis again will give you a snapshot of the data, including all the information you need in a single chart; open interest, volume, and price movement. Using the proper analysis tools, you can determine if a trade is worth entering or not within minutes.
- The other weak spot of fundamental analysis where technical analysis excels is that technicians easily estimate their profit targets and risk management parameters. The fundamentalists, on the other hand, are exposed to a pretty significant degree of risk.
- Prices move in trends: If prices just gyrated anyhow, it would be very hard to make money through this analysis. While some wild moves occur sometimes, the overall prices move in trends.
The most profitable trading strategies used by traders are trend-following. Here, you isolate the trend and find a way of entering some direction of the trend. Basically, you benefit from directionally biased price movement.
- With technical analysis, you’ve got the ways to time your trades. You can wait and use your money for other opportunities until that time when the market is ready to move higher.
- You can apply your knowledge on technical analysis to various markets like forex, stocks, futures, binary options, CFDs, among many others. Different patterns of human behaviour affect market trading, and these patterns are reflected on price charts across markets.
You can use technical analysis on any time frame – whether you trade 60 seconds, daily or weekly charts.
Read about the Elliot Wave Rules to catch tops and bottoms in the market.
Disadvantages of Technical Analysis
So said about technical analysis and the benefits it has to the trader, but that doesn’t make it flawless. It has its share of disadvantages.
Mixed Signals Of Technical Indicators
Sometimes, you could be confused when a technical indicator shows a buy signal, and at the same time, another shows a sell signal. This leads to confusion when making trading decisions.
Thus to ensure the strategy doesn’t work against you, you’ve to combine these indicators and moving averages to determine exit and entry points.
Accuracy
You can use technical analysis to forecast market activity, and all indicators give possible entry and exit points. Thus the accuracy isn’t 100%. For instance, if an entry or exit point of stock is suggested, it’s not guaranteed that the trade will be successful. After entry, stocks may decrease or rise after exit.
Contradicting Opinions
Technical analysis allows for opinions, and one analyst’s opinion may differ from another’s. Thus it may be challenging to make a beneficial prediction.
Technical Analysis Tips To Boost Your Trends
As aforementioned, technical analysis is an ingenious trading strategy that you can use to make profits when trading with any securities.
However, it will only benefit you if you know how to apply it perfectly in your trading.
Following are a few technical analysis secrets you can use to boost your trend.
Secret 1: Trade With The Trend
If your indicators are showing that the securities are on an upward trend, and then buy it. When the trend stops, it’s time to sell. If you can’t figure out what’s happening, then don’t trade.
Don’t fall into the “value trap” – that the high-value security will be back after a fall. That can happen, but it may take ages to come back, and as you wait, you miss opportunities for building capital.
Secret 2: Every Indicator Works
Indicators will help you identify both buying opportunities and warnings on when you should opt-out and sell. There are dozens of indicators in the world of technical analysts that you can use. No single best, but there are a few that can be beneficial to you. It’s simple; use indicators that you’re comfortable with, and you trust that they can perform well and consistently.
Secret 3: Every Indicator Will Fail At Some Point
Any form of trading will, at one point, go into losses. That’s a fact you’ve to keep at the back of your mind. The market could go haywire and behave oddly. It’s called the “luck factor” and does not mean your indicator skill is defective.
Again, the same indicator could lead you to some gigantic gains. It’s also abnormal market behaviour and doesn’t make the indicators magical or your skills exceptional.
Secret 4: If You Can’t Accept Losses, Don’t Trade
Who doesn’t get excited when they win anyway? As you begin trading using technical analysis, be ready for losses. Therefore, you must adopt the right strategies to control them ruthlessly and preserve capital.
Bad indicators are not the biggest cause of losses, but the failure to admit the indicators are sometimes wrong is. Technical analysis should help you make money and not prove whether indicators are right or wrong.
If you can’t control the occasional loss, you can’t make money. A stop-loss order is the perfect tool for managing losses.
Secret 5: Interpreting What the Indicator Says About Crowd Sentiment
Indicators show whether a security is trending, the strength, and when the trend runs out of steam. No single indicator measures everything, so you’ve to understand the aspect of crowd sentiment the indicator is focused on.
Secret 6: Look For the “Eureka” Moment
There are thousands of trading ideas contained in technical analysis, new combinations of indicators, new securities, and new strategies invented all the time. Sometimes it can be intimidating and frightening, but you should persevere.
At some point, you’ll land something that resonates with you, and that could be your avenue to a “jackpot.“
Conclusion
When using technical analysis in trading, learn to observe human behaviour and keenly follow the footprints of the previous price action. That way, you’re able to guess what could happen next. That is because history has a tendency of repeating itself, and markets move in trends.
Related Articles:
25,000 hours of testing 70+ brokers. Our recommended broker is Pepperstone.
Our recommended broker is Pepperstone.