Technical Analysis

Defining Technical Analysis:

To the right, we see an image of what looks like a bunch of lines on a chart. To the untrained eye, it all looks like a jumbled mess in my opinion.

So what really is technical analysis?

Technical analysis is a method used in financial markets to evaluate and forecast the future price movements of assets, such as stocks, currencies, commodities, or indices. This analysis relies on the examination of historical price charts, trading volume, and other market-related data to identify patterns and trends that may help traders make informed decisions.

Technial analysis can come in all sorts of shapes and sizes. Technical analysis can mean all of the following: Price action, market structure, stock indicators, volume price analysis, trendlines, support and resistance (also called supply and demand), S/R flips (also called break and retests), harmonics, volume profile, elliot waves, candle stick patterns, chart patterns, and even simple price action trading.

Sound overwhelming? It is in the beginning. But I am here to guide you through what is BS, and what’s legit using my 3 years of trading options experience. Let’s dive in below.

Technical Analysis: Chart Types, Stock Market Indicators, and Asset Classes

Now there certainly is NOT a one answers all here. Technical analysis is largely a art, not a science. It may seem backwards, but it is. In my opinion, it is half art, half mathematics. I personally use volume price analysis, candle stick charts, support and resistance, and market structure in my trading. These aspects are the art of the profession. Being able to depict these concepts on a chart comes with any other skill or hobby you are trying to master, time and repetition. The mathematics part is defined by backtesting, E = (AW * PW) – (AL * PL), risk management, and using your “edge”. Think of trading as a casino. But instead of the casino having their own rules, you make the rules. Using these rules can guide you to having a profitable “edge” in the market, and that is exactly what we are after.

1. Asset classes:

Technical analysis can be applied to various assets. To name a few of the most popular: stocks, currencies (forex), commodities (gold, siver, corn), indicies (S&P500), cryptocurrencies (bitcoin), bonds, options and futures, and finally ETFs (think basket of invidual stocks).

I personally have experience trading forex, options, futures, and stocks. I have invested in cryptocurrencies, but never traded them actively.

2. Chart types:

Without going too in depth about the different chart types, the three main chart types are line charts, bar charts, and candlestick charts.

Line charts: A line chart connects individual closing prices with a line. Each data point represents the closing price of the asset over a specific time period. Line charts are useful for providing a simple, overall view of the price trend over time. They are commonly used for long-term analysis and to identify general trends.

Bar charts: A bar chart provides more information than a line chart. Each bar represents the high, low, open, and close prices for a specific time period. The top of the bar represents the high, the bottom represents the low, and the horizontal lines on the left and right sides indicate the open and close. Bar charts are used to provide a more detailed view of price movements. Traders can quickly see the price range for a given period and whether the close was higher or lower than the open.

Candle stick charts: Similar to bar charts, candlestick charts show the high, low, open, and close prices for a specific time period. However, the body of the candlestick is filled or hollow, with the color indicating whether the close was higher or lower than the open. Filled (or red) candles represent a lower close, while hollow (or green) candles represent a higher close. Candlestick charts are popular for their ability to convey more information about price action and market sentiment.

Other chart types include renko charts, point and figure charts, and kagi charts. I do not have experience in any of these chart types. If I had to guess, I would assume the line and candlestick charts are the most popular among technical analysis traders.

Each type of chart has its advantages and is suitable for different trading styles and preferences. Traders often choose the chart type that best aligns with their analysis and decision-making processes.

3. Market indicators:

Technical analysis relies on various indicators to help traders analyze price movements, identify trends, and make informed trading decisions. Here are some commonly used technical analysis stock indicators:

Moving Averages:

Simple Moving Average (SMA): The average closing price over a specified period, providing a smoothed trend line.

Exponential Moving Average (EMA): Similar to SMA, but it gives more weight to recent prices, making it more responsive to changes.

Relative Strength Index (RSI):

Measures the speed and change of price movements. RSI values above 70 suggest overbought conditions, while values below 30 suggest oversold conditions.

Moving Average Convergence Divergence (MACD):

Consists of two moving averages, the MACD line and the signal line. Traders look for crossovers and divergences to identify potential trend changes.

S/R Flip:

When a support or resistance level is broken, price returns to the level, and the previous support or resistance now becomes the opposite.

Stochastic Oscillator:

Measures the closing price relative to the price range over a specified period. It helps identify overbought or oversold conditions.

Fibonacci Retracements:

Based on Fibonacci sequence levels, traders use retracement levels (38.2%, 50%, 61.8%) to identify potential support or resistance levels.

A trader can be attracted to using these indicators as a crutch if you will. There is a common trend when it comes to new traders in that the more indicators = the better. Which is simply untrue. As a new trader, stay away from the indicator obsession. It is my belief that traders should soley focus on price action and volume as the primary trading tool. Indicators are used best when they are support, not the entire argument for taking a trade.

Now, I will admit, this is my personal opinion. But volume price analysis (the relationship between price and volume) is the best indicator there is.

Example Line Chart:

Click the drop down arrow next to the chart types and select the line chart.

My personal favorite is the line with markers chart. I use this chart for plotting the market structure. Try to identify higher higher, higher lows, lower highs, and lower lows on the line with markers chart.

Example Candle Chart:

Click the drop down arrow next to the chart types and select the candle chart.

I use the candle chart to understand the price action during the day. For example, you would not see price “wicked” down or up to a certian level on the line with markers chart. The line chart plots the daily candles close if that is the time frame you are using. The candle chart will show me how price acted throughout the daily candle.

Technical analysis: Swing trading vs. day trading

Technical analysis of the financial markets can be applied in two different forms of trading. The two forms are swing trading and day trading. How do they differ? The main differences are time horizon, frequency of trades, and risk exposure.

Time horizon:

The primary distinction is the time frame. Day trading is short-term, with positions closed within the same day, while swing trading has a somewhat longer time horizon, holding positions for several days to weeks.

Frequency of trades:

Day traders make multiple trades in a single day, seizing on intraday volatility. Swing traders, on the other hand, execute fewer trades, focusing on capturing intermediate-term price swings.

Risk exposure:

Day traders face minimal overnight risks as they close positions before the market closes. Swing traders, holding positions overnight, are exposed to potential gaps in price when the market opens.

Similarities: Swing and day traders have much more in common than they do different. Both kinds of traders are likely to use all of the previously mentioned content, just on different time frames. Day traders are focused on the mirco movements. Swing traders are focused on longer-term timeframes like the daily, weekly, and monthly stock charts. Both will use fibonacci retracements, price action, support and resistance (supply and demand), volume price analysis (VPA), and price action trading. They will often use the same stock market patterns, same chart types (candlestick charts, line charts, bar charts), and trading strategies. The biggest difference is the timeframes they are trading off of. The stock market has a funny way of acting similar across time frames. For example, you would likely find a head and shoulders stock pattern on the weekly chart. But you are also just as likely to find a head and shoulders pattern on the 5 minute chart as well.

Technical Analysis Educational Videos:

The Art and Science of Technical Analysis Trading:

Introduction: Technical analysis trading is a dynamic and widely practiced approach to analyzing financial markets, with a primary focus on historical price data and market statistics. Traders employing technical analysis use a variety of tools, indicators, and chart patterns to make informed decisions about buying and selling financial instruments. This essay delves into the key principles and methodologies of technical analysis trading, exploring its strengths, limitations, and its role in shaping the strategies of market participants.

Principles of Technical Analysis: At the core of technical analysis is the belief that historical price movements and trading volumes contain valuable information about future market trends. Traders analyze price charts, seeking patterns and trends that can provide insights into potential future price movements. Here are some foundational principles of technical analysis:

1. Price Discounts Everything: Technical analysts contend that all relevant information, including fundamental factors, economic data, and market sentiment, is already reflected in the current market price. As a result, they focus on price action to make trading decisions.
2. Price Moves in Trends: The concept of trends is central to technical analysis. Traders identify and follow trends, which can be upward (bullish), downward (bearish), or sideways. Trend analysis helps traders make predictions about future price movements.
3.  History Tends to Repeat Itself: Technical analysts believe that historical price patterns and market behaviors tend to repeat over time. By recognizing and understanding these patterns, traders aim to anticipate future market movements.
4. Support and Resistance Levels: Key price levels, known as support and resistance, play a crucial role in technical analysis. Support is a level where buying interest is significantly strong, preventing the price from falling further. Resistance is a level where selling interest is substantial, preventing the price from rising further.

Tools and Indicators: Technical analysts employ a diverse set of tools and indicators to enhance their decision-making process. Some common ones include moving averages, relative strength index (RSI), moving average convergence divergence (MACD), Bollinger Bands, and Fibonacci retracements. Additionally, things like price action, volume, support and resistance (supply and demand), volume price analysis, and market structure are leading indicators. These tools help traders identify trends, potential reversals, and overbought or oversold conditions.

Chart Patterns: Chart patterns are visual representations of historical price movements that can indicate potential future price trends. Some well-known patterns include head and shoulders, triangles, double tops, and flags. Traders use these patterns to make predictions about the continuation or reversal of trends.

Strengths of Technical Analysis Trading:

1. Objective Approach: Technical analysis provides a systematic and objective framework for decision-making. Traders rely on concrete data and observable patterns, reducing the impact of emotions on their trading decisions.
2. Short-Term Trading Opportunities: Technical analysis is well-suited for short-term traders, including day traders and swing traders, who aim to capitalize on short-term price movements.
3. Versatility: Technical analysis can be applied to various financial instruments, including stocks, currencies, commodities, and cryptocurrencies. Its versatility allows traders to adapt their strategies to different markets and asset classes.

Limitations of Technical Analysis Trading:

1. Not Predictive: Critics argue that technical analysis does not predict future price movements with certainty. While it can provide insights, it does not guarantee success, and market conditions can change rapidly.
2. Limited by Historical Data: Technical analysis relies on historical price data, and its effectiveness may be limited in unprecedented market conditions or when faced with unexpected events.
3. Overlapping Information: Some critics suggest that much of the information used in technical analysis is already reflected in market prices, making it challenging to gain a significant edge over other market participants.

Conclusion: Technical analysis trading is a powerful and widely adopted approach in financial markets. Its principles and tools offer valuable insights into market trends and help traders make informed decisions. While it has its strengths, including objectivity and versatility, it is essential for traders to recognize its limitations and use technical analysis as part of a comprehensive trading strategy. The dynamic nature of financial markets requires a combination of technical analysis, fundamental analysis, and risk management to navigate successfully and adapt to changing conditions. As with any trading approach, continuous learning, discipline, and adaptability are key factors in achieving long-term success in technical analysis trading.