Learning about technical analysis will give you a trading edge in analyzing price action in all sorts of ways to make sound trading decisions just like the pro’s do everyday.
What Is Technical Analysis?
Technical analysis is the study of price action, volume, and charts over a period of time to predict future price movements. It can assist you in determining “when” to buy a company’s stock (or any other type of financial instrument) according to its price action, but not necessarily “why” since you are not doing involved fundamental or financial analysis on the company. Although technical analysis can be used for any type of trading style, shorter-term traders that day trade and swing trade use it almost exclusively.
What Technical Analysis Is Not
- Having to know anything about the fundamental business operations of a company. “Technical” traders may not even know what kind of products the company sells, how big (or small) the company might be or where the company is even located.
- Pouring over countless hours of financial data. Rarely do technical traders crack open the quarterly or annually audited financial statements of a company. Therefore, you don’t need to spend any time scrutinizing the company’s financial statements like the balance sheet, income statement, statement of cash flows or accompanying footnote disclosures. In this regard, you don’t need to know anything about corporate accounting, corporate finance or other areas of fundamental analysis.
What Technical Analysis Is
- Analyzing the price action of a stock (or any other type of financial instrument) on a chart using your favorite methods of technical analysis
- Giving you guidance for predicting future price movements
- Helping you to determine when to enter and exit the markets at opportune times
Technical Analysis “Is Like Having Your Own Personal Trading Tool Box”
There are many timely tested and interesting ways to analyze price action using technical analysis. Below are just some of the ways that professional traders use technical analysis to analyze price action in order to help guide them in determining when to enter and exit a trading opportunity.
Oscillators And Indicators
- Stochastics
- Bollinger Bands
- Moving Averages
- Relative Strength Index (RSI)
- Average Directional Index (ADX)
- Moving Average Convergence Divergence (MACD)
Charts – The “Crown Jewel”
By far the chart is the heart and soul of any trader using technical analysis. Charting allows you to visually see the history and behavior of actual price action. Charts can be used to analyze:
- Uptrends, Downtrends, and Sideways Trends
- Chart Patterns
- Candlestick Formations
- Volatility of Price Movements
- Cycles of Peaks and Valleys
- Strong Support and Resistance Areas
- Price “GAPS”
With charts you can instantly zoom-in and zoom-out of different time frames and frequencies including:
- 10 years, 5 years, 1 year, 6 months, 3 months, 1 month, daily and intraday (such as 1 hour, 30 minutes & 5 minutes etc.)
- Daily, Weekly, Monthly and Yearly
Charts can display price action in different graphical styles like:
- Bar Charts
- Line Charts
- Mountain Charts
- Japanese Candlesticks
Japanese Candlesticks – The Clear Winner
Japanese candlesticks offer you additional insights into price action and patterns that the other charting styles fall short on.
Candlesticks are formed by using the opening, high, low and closing prices over a particular trading session. They can form into many different types of candlesticks ranging in all kinds of meaningful shapes and sizes. As a result, candlesticks may vary widely and can appear with:
- A “real body” (or no real body)
- Upper and lower “shadows” that extend outward from the real body (or even no shadows at all)
Japanese candlesticks give life and exposure to charts by illuminating the price action. Typically, candlesticks are shown in one of two popular colors (red and green). The color is determined by the relationship of the opening and closing prices.
Candlesticks can also help to provide clues and signals in predicting future price movements such as continuation (or reversals) of price trends and the force behind price movements.
Due to the nature of candlesticks, they have been given many interesting names from being passed down centuries ago originating from Japanese rice traders.
Some of the candlestick names include:
- Doji (learn about Trading The Doji)
- Harami
- Hammer
- Morning Star
- Hanging Man
- Shooting Star
- Gravestone Doji
- Engulfing Pattern
- Dark Cloud Cover
- Key Reversal Bar
(to learn more about candlesticks, see our article about Meet the Recognized Leading Authority Who Introduced Japanese Candlesticks to the Western World)
Chart Patterns – The Geometry Of Technical Analysis
The evolution of chart patterns goes back in history for a long time and holds a strong footprint for predicting future price movements. As the saying goes in the trading world – since history has a tendency to repeat itself over and over again, so does the history of chart patterns.
Many technical traders have a strong allegiance to chart patterns and they rely heavily on them for making trading decisions (both short-term and long-term).
Just like artwork, chart patterns have their own unique etchings and landscapes with having such decorative names as:
- Pennants
- Flags
- Double Bottoms
- Wedges
- Cup and Handles
- Diamond Bottoms
- Bottom Triangles
- Head and Shoulders
- Megaphone Bottoms
- Ascending Triangles
These are just a few of the many interesting and powerful chart patterns that traders can use. It is highly recommend that you learn a great deal about chart patterns to help you make your own trading decisions.
(see our article about a trader who uses chart patterns almost exclusively – Former Pool Contractor Becomes Legendary Stock Trader Turning $11k into $42 MILLION in 23 mo.’s)
Trend Lines – Drawing Lines To Profits and Safety
Trend lines can be drawn on a chart to help identify such things as strong areas of support and resistance, potential breakout points on chart patterns and measuring channeling areas of trends. They can also be used as lines of reference to draw your “lines in the sand” of when to enter and exit trading positions.
Advanced Theories Of Technical Analysis
- Elliot Wave Theory
- Fibonacci Retracements
- Gann “Fan”
- Cycle and Seasonal Analysis
If you are new to technical analysis, a good place to start is with the more basic parts of it before leaping into these more advanced theories.
Final Thoughts – About Technical Analysis
Because technical analysis is such a diverse and broad discipline, it is not necessary for you to fully understand all of it before you can become a successful trader. Actually, far from it.
It is recommend that you obtain a sufficient amount of knowledge about technical analysis so that you can start to narrow it down and decide for yourself which areas of it will best suit your trading style and trading objectives.
Once you get good at using your favorite methods of technical analysis, you can always build upon it down the road to further expand your knowledge base from this invaluable theory about price action.
Bottom line about technical analysis – it just may be the rainbow that will lead you to your own pot of gold in trading!
