This trading discipline is employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.
What is Technical Analysis?
Technical analysis is the framework in which traders study price movement.
The theory is that a person can look at historical price movements and determine the current trading conditions and potential price movement.
The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price.
Support & Resistance
The “bar” of the chart shows you the opening/closing price for that time interval (be it one minute, one day, one month, etc). Charts typically use a red color to show a loss and green color to show a gain.
The “wick” is showing you the highest/lowest price reached during the time interval.
When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance. As the market continues up again, the lowest point reached before it started back is now support.
In this way, resistance and support are continually formed as the market oscillates over time. The reverse is true for the downtrend.
Keep in mind that this is not perfect, support and resistance levels are not exact numbers.
Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it.
With candlestick charts, these “tests” of support and resistance are usually represented by the candlestick shadows.
Think of support and resistance more of as “zones” rather than concrete numbers.
More About Support & Resistance Levels
- When the price passes through resistance, that resistance could potentially become support.
- The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
- When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.
In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys).
In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).
More On Trend Lines:
- It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.
- The STEEPER the trend line you draw, the less reliable it is going to be and the more likely it will break.
- Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.
- And most importantly, DO NOT EVER draw trend lines by forcing them to fit the market. If they do not fit right, then that trend line isn’t a valid one!
Channels are another tool in technical analysis which can be used to determine good places to buy or sell.
Both the tops and bottoms of channels represent potential areas of support or resistance.
- To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to position where it touches the most recent peak. This should be done at the same time you create the trend line.
- To create a down (descending) channel, simply draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley. This should be done at the same time you create the trend line.
When prices hit the LOWER trend line, this may be used as a buying area.
When prices hit the UPPER trend line, this may be used as a selling area.
More On Channels:
- When constructing a channel, both trend lines must be parallel to each other.
- Generally, the bottom of channel is considered a buy zone while the top of channel is considered a sell zone.
- Like in drawing trend lines, DO NOT EVER force the price to the channels that you draw!
Let’s take a look at the most popular chart used in Technical Analysis
- The “bar” of the chart shows you the opening/closing price for a time period (be it one minute, one day, one month, etc).
- Charts typically use a red color to show a loss and green color to show a gain.
- The “wick” is showing you the highest/lowest price reached during the time period
Candlesticks come in different Sizes
- Long green Japanese candlesticks show strong buying pressure.
- The longer the white candlestick, the further the close is above the open.
- This indicates that prices increased considerably from open to close and buyers were aggressive.
- Long black (filled) candlesticks show strong selling pressure.
- The longer the black Japanese candlestick, the further the close is below the open.
- This indicates that prices fell a great deal from the open and sellers were aggressive.
Some Basic Candlestick Patterns
Characteristics: A long upper shadow, long lower shadow and small real bodies.
Indicates: Indecision between the buyers and sellers.
Neither buyers nor sellers could gain the upper hand, and the result was a standoff.
Characteristics: A long green body with no shadows
Indicates: A very bullish candle as it shows that buyers were in control the entire session. It usually becomes the first part of a bullish continuation or a bullish reversal pattern.
Characteristics: A long red body with no shadows.
Indicates: A very bearish candle as it shows that sellers controlled the price action the entire session. It usually implies bearish continuation or bearish reversal.
Doji candlesticks have the same open and close price or at least their bodies are extremely short. A doji should have a very small body that appears as a thin line.
Doji candles suggest indecision or a struggle for turf positioning between buyers and sellers.
Prices move above and below the open price during the session, but close at or very near the open price.
Read more about different Candlestick patterns here: https://www.babypips.com/learn/forex/lone-rangers-single-candlestick-patterns