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What is technical analysis?What is technical analysis?

May 13, 2022 8 min reads

Technical analysis (TA) is an analysis methodology for forecasting the direction of prices through the study of past market data, primarily price and volume. Long-term investors use some special technical indicators to catch the best entry and exit points.

People who work with technical analysis are called technical analysts, or technicians or chartists. Their work consists of examining price data and volume in order to calculate market sentiment or traders’ feelings about the state of the market: whether it’s bullish or bearish. They analyze price changes within a specific timeframe, as well as identify patterns that could predict future price movement and initiate trading signals.

History repeats

One of the theories of technical analysis is that the history of price action is quite predictable and tends to repeat itself. That can be true as there are human beings on the market and their emotions are predictable which drive the price action. The formula is simple: the past price action that is the result of human behavior will resemble the future price movement if human behavior doesn’t change.

The trend is your friend

One more popular assumption in technical analysis is that the price usually moves with trends in a zig zag-like pattern. The asset price can move in different directions: it can be an upward trend, that creates a higher high and lower high, or in a downward trend, creating a lower and lower high, or it can move sideways (flat). Usually an existing trend continues until it reaches a turning point of support or resistance. At this point the price can reverse and change direction.

Support and resistance

Support and resistance are used by traders to refer to price levels on charts that prevent the price of an asset from getting pushed in a certain direction. Support is a price level, where a downtrend can be expected to pause due to a concentration of demand or buying interest where a resistance is opposite. Though a trend may have its one-way direction, that may result in a break-out situation when the price pierce support and resistance. These two methods are more common for short time periods and are used by day traders: they sell resistance and buy support.

Patterns

A chart pattern is a shape within a price chart that suggests the next price move, based on the past moves. There are two types of patterns: continuation and reversal patterns. They include triangles, pennants, rectangles, and flags, as well as head and shoulders, double and triple tops and bottoms, and cup and handle. As we said before, the market can be bullish or bearish so are the patterns. Traders use these patterns and other indicators to make their trading decisions.

Volume

Another important component of TA is volume. Volume is the sum total of actual trades taking place over a given time frame. Traders tend to use the volume indicator as an attempt to gain a better understanding of the strength of a given trend. If volatility in price is accompanied by high trading volume, it may be said that the price move has more validity. Conversely, if a price move is accompanied by low trading volume, it may indicate weakness of the underlying trend.

Momentum

Momentum is the speed of price change when the price moves in one direction over a period of time. Trades also use this indicator to understand the market situation more clearly and determine the strength of a trend.

Technical indicators

Momentum is the speed of price change when the price moves in one direction over a period of time. T

As we mentioned earlier, the market price is based on the interaction between buyers and sellers and determined by the volume of demand and supply. Technical indicators help traders to foresee changes in the dynamics of demand and supply and human behavior on the market. Technical indicators were created from historical price changes and are math-based. Analysts use them to choose the best time to enter or exit the market.

Let’s have a look  at the most popular and common indicators: Bollinger Bands (BB), Moving averages, MACD, and RSI. For instance, the RSI determines whether an asset or security is overbought or oversold and thus displays best momentum-based entry and exit points for traders.

There are the following types of technical indicators:

Trend indicators

  • Moving Average Convergence-Divergence (MACD)
  • Moving averages
  • Know Sure Thing (KST) Oscillator
  • Parabolic SAR

Momentum indicators

Volatility indicators

Volume indicators

  • Accumulation/distribution Index
  • Money Flow Index
  • On-balance Volume

Types of charts

There are different chart formats that display the past and current price action of the market. These are: line, bar, candlesticks, O-H-L-C. Let’s have a more detailed look at the most commonly used type – candlesticks.

The candle has a top, bottom, and body. The top of the candle highlights the highest price point and the bottom is the lowest. The upper body of the candle marks the opening price, the bottom – the closing price.Candlesticks give you an instant snapshot of whether a market’s price movement was positive or negative, and to what degree. The timeframe represented in a candlestick can vary widely: it can be one minute, hour, day, week, or month. Experienced traders look for patterns in order to gauge market sentiment and to make predictions about where the market might be headed next.

Charting on different time frames

Momentum is the speed of price change when the price moves in one direction over a period of time. Traders can also use different time frames to check the past and current price action. The most commonly used for short-time trading is the 4-hour time-frame. The types of time frames can be the following: 5-15-30 minute chart, hourly chart, 2-hour chart, 12-hour chart, daily chart, weekly chart.

Conclusion

Technical analysis might look simple to understand when you look at it from the theoretical side of view. However, it has many nuances and a variety of components included there that makes it complicated to implement on the real-based markets. Thus, TA teaches traders to use historical price actions to find profitable trading opportunities.

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