Technical analysis is the framework in which traders or the so-called ‘technical traders’ study the price movements. The theory suggests that history tends to repeat itself and this is how it can determine the next potential move. Traders use it because they believe that all the available information is reflected in the charts. Therefore, technical analysis is widely used because if all available information is reflected in the charts then price action is all one needs to enter a trade.
Technical analysis is not about prediction but more about probability!
There are three main types of analysis that traders, analysts, and investors use. The first one is fundamental analysis, the second one is technical analysis and the third one is sentiment analysis.
Investors base their next moves on fundamental analysis such as the industry news that can be sudden and unexpected, or revenue and valuation. The thing is that fundamentals are not always reflected in the chart. This is where technical analysis comes to examine deeper the price action and historical data along with volume.
The first thing that comes to mind when talking about technical analysis is charts. Charts are the easiest way to visualize historical data. Traders look at past cycles or movements to identify trading opportunities. A candlestick chart looks like this:
You should keep in mind that technical analysis is very subjective. If you and I do technical analysis at the same time it does not mean that we will both come up with the same outcome. So, what’s the important thing? The most important is to understand technical analysis and its concepts. We don’t want you to pull your hair every time someone talks about Bollinger bands, RSI, MACD, or Fibonacci retracements.
Since charts are the best way to start learning you should know that charts can be adjusted to your preferred time frame. Charts time frame range from 1 minute to even 5 years. However, the most common time frames to use are:
The candlesticks charting that form the patterns on the charts are presenting the price action according to the time frame. There are many different candlesticks patterns that can help traders spot a bearish signal or a bullish signal. If you already have a demo account is better to practice what you read at the same time.
Good, now that you opened your demo account click on the 15-minute chart. Now change it to the 1-hour chart. Did you notice that the candlesticks are formed differently when you change the time frame? This is because each candlestick represents the amount of time you choose. On the 15-minute chart, for example, each candlestick represents a 15-minute price movement whereas on the 1-hour chart each candlestick represents a 1-hour price movement.
For example, if a trader is looking to benefit from a short-term trade it will choose the 15-minute chart to spot a closer opportunity that can be fulfilled on the same day. Likewise, a long-term trade will be looking at a 4-hour website or even a daily and weekly time frame to spot a further opportunity that will probably take more than 1-day to be reached.
To enhance your candlesticks pattern understand click the link on the candlesticks above!!
Don’t worry I won’t bore you!! I just want to show you some technical indicators that are widely used.
Moving averages is actually one of the most widely used technical indicators. It is simply helping traders to smooth out the price fluctuations that are taking place.
As you can see the moving average line is on top of the candlesticks forming a trend direction. But why is it helpful you ask? Well, unfortunately, trends do not move in straight lines. So, we use moving averages to see the trend direction.
Don’t worry by the end of this session you will also be smooth like moving averages.
Moving averages come in many different types. The two major ones are the Simple and the Exponential. You can find the full explanation here.
Remember moving averages do not predict the future price direction, instead, they provide a clear view of the current one.
MACD stands for moving averages convergence divergence. It is used to identify moving averages that show a new trend direction. In order to use it, you need two moving averages the one longer than the other. The most common one is 26-period and 12-period so you can subtract the longer from the shorter one. This leaves as with a 9-period MACD line.
This is how a MACD indicator is shown. The histogram is becoming bigger the two moving averages separate from each other.
This is also called the divergence because the longer moving average moves away (diverges) from the shorter one. The opposite will happen when the histogram gets smaller. That’s right, the two moving averages are getting closer or converge.
Well done, you just learned another indicator. For further explanation on how to use it click here!
Let’s talk about Fibonacci retracement levels. They are used to identify support and resistance levels in the stock price. What does that mean? A potential reverse on the price. Support can be viewed as the floor where the price stands and cannot fall below. Resistance can be viewed as the ceiling that the price is trying to break in order to go up.
Fibonacci Retracement levels look like this:
They should be placed from the highest point to the lowest price of the time frame you are looking at. If it is a bullish market the fib retracement levels will be placed from the bottom all the way to the top and vice versa.
As you can see the levels used are 0, 0.236, 0.382, 0.5, 0.618, 0.786 and 1. The most important ones are 0.5 and 0.618. Why? Because the resistance (Ceiling) at 0.5 was broken and became a new support(floor) level that gave a boost to a bullish trend. If you want to learn more about fib retracements click here!
There are more technical indicators that we will learn in more advanced stages! Today you understood technical analysis and why is it very widely used! That’s great. If you start practicing it on your demo today, you will become better by the day.
Well done!! You now know what technical analysis is!