Complete Guide to Technical Analysis

March 31st 2022 15 min read

How well do you know the financial market? Do you know what options trading and technical analysis are? Do you want to develop a clear understanding of technical analysis of the financial market? This piece uncovers relevant details about trading and technical analysis of financial markets. Various trading techniques are used by traders to evaluate investments, and they have proven to be effective.

Keep an open and focused mind as we take you through various technical analysis methods, and their importance. We will also go through the types of indicators and learning resources for further reading.

At the end of your journey, you will have full knowledge about the most effective technical analyses that can be used in trading in various financial markets. Those looking to get into trading and those who have a basic understanding of trading will enjoy this article while anyone having second thoughts about going into trading will get the motivation they need.

Now that we have established an understanding of what you would get from this piece, and who should read it, let’s go into details.

What is Technical Analysis?

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Technical analysis is regarded as a trading technique used to predict future price movements. It is also used in the evaluation of investments as well as identifying opportunities in the financial market. The evaluation and identification are carried out by analyzing statistical trends that have been acquired from a trading activity such as price movement and trading volume.

Most technical analysts in the financial markets believe that a valuable indicator of a security’s future price movements is related to past trading activities and price changes. Note that technical analysis can be mistaken for essential analysis. The essential analysis in question is focused on the finances of a company instead of a chronological price pattern or trends.

While fundamental analysis assesses a security’s value based on business performance like earnings and sales, technical analysis is a study of volume and price. It is worthy to note that technical analysis of stocks serves as a tool used in analyzing the methods in which demand and supply for securities will affect the changes in volume, price and volatility.

Importance of technical analysis

Technical analysis shows its importance when predicting market prices. This means that it focuses on looking at the market prices and patterns. Technical analysis in stocks is quite different from fundamental analysis because fundamental analysis revolves around market research that identifies the drivers of market prices.

How does technical analysis help traders?

Technical analysis helps traders in several ways. This trading technique has relevance in analyzing any security that has historical data. Some of the securities include futures, currencies, stocks, commodities, and fixed-income among others.

Technical analysis is more useful in analyzing foreign exchange and commodity markets as traders put more focus on short-term movement in prices. Technical analysis doesn’t only help traders to create opportunities when investing and trading, it also assists in reading price patterns and market prices.

Advantages of technical analysis

Technical analysis of financial markets offers great advantages when applied with trading instruments within a specific timeframe. The examination of interest rates, stocks, forex, and commodities is one of the major advantages of technical analysis. Various technical analysis techniques can be applied to charts on intra-day, weekly and monthly time frames.

The notable advantage of technical analysis can be seen in its diversity and uniqueness. This means that technical analysis can be unified with a few strategies, or can be used as a lone indicator. Expert traders and investors use this analysis to set rules and strategies that will aid the process of decision making. The decisions involve forecasting future price movement, timeframes, and the strategy used in entering and exiting a trade.

Technical analysis helps in forming a fraction of your trade plan and creating rules that can be used when entering and exiting a trade. Trend indicators, as well as chart patterns, help in the application of techniques and tools for creating trading opportunities. Most of these opportunities lie in the financial markets globally and they aid in making trading a success.

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Types of Indicators

Have you ever thought about how to trade using technical analysis patterns? Well, wonder no more, this post will tell you about four common indicators as well as ways of profiting from these indications.

Trend Indicators

If there is a trend in the market, trend indicators will tell you which way it is moving. They're termed oscillators because they move in a wavelike pattern between high and low levels. We'll talk about Moving Averages, Parabolic Stop and Moving Average Convergence Divergence as trend indicators (MACD).

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Moving averages

A moving average is a statistical computation that is used to examine data points by calculating the averages of different subsets of the entire data set. When dealing with time-series data, a moving average is widely employed to smooth out short-term variations while highlighting longer-term patterns or cycles. The short-term vs. long-term threshold is determined by the application, and the moving average parameters can be adjusted accordingly. It is frequently utilized in analyzing financial data, such as stock prices, returns, and trading volumes.

In economics, it's also used to look at macroeconomic time series like GDP (Gross Domestic Product), employment, and so on. A moving average is a sort of convolution in mathematics, therefore it may be thought of as a signal processing low-pass filter. When applied to non-time series data, a moving average selects higher frequency components without regard to time, some sort of order is usually implied. It may be thought of as just smoothing the data.

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Parabolic stop

The Parabolic Stop and Reverse, or "SAR," technique is a technical analysis tool that uses price and time to determine the trailing stop-loss of a currency trend. The method was created to fill in for any unintended gaps in other technical indicators. Although the parabolic system is not an oscillator, it can be used with one to improve results. The indicator's dots indicate possible price behavior and reversal points in the trend being monitored. When the location of the dots shifts from one side of the asset's price to the other, the parabolic indicator gives buy and sell signals. A purchase signal is generated when the dots move from above to below the price, whilst a sell signal is generated when the dots move from below to above the price.

Traders may also place trailing stop-loss orders using the PSAR dots. If the price is increasing and the PSAR is rising as well, the PSAR might be utilized as a possible exit if you have opened a long position. Stop the long trade if the price falls below the PSAR.

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Moving Average Convergence Divergence

Moving average convergence divergence (MACD) is a trend-following momentum indicator that depicts the connection between two security's price moving averages. By subtracting the 26-period EMA from the 12-period EMA, the MACD is computed.

The MACD line appears as a result of such computation. The "signal line," a nine-day EMA of the MACD, is then drawn on top of the MACD line, which may be used as a buy and sell signal trigger. When the MACD crosses above (buy) or below (sell) its signal line, it generates technical indications.

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Momentum Indicators

Momentum indicators are technical analysis indicators that are used to identify a stock's price strength or weakness. The rate at which stock prices increase or decrease is referred to as momentum. Momentum is a very important sign of strength or weakness in the price of a trending market. History has demonstrated that momentum indicators are significantly more effective in rising markets than in declining markets. This is because markets rise more frequently than they collapse. We'll talk about the Stochastic Oscillator, Commodity Channel Index, and Relative Strength Index.

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Stochastic Oscillator

A stochastic oscillator is a momentum indicator that compares a security's closing price to a range of the security's prices across time. By altering the period or taking a rolling average of the result, you may reduce the oscillator's susceptibility to market swings. Using a 0–100 limited range of numbers, it is used to produce overbought and oversold trading signals.

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Commodity Channel Index

The Commodity Channel Index (CCI) is a technical indicator that compares current prices to historical average prices.

This technical indicator, created by Donald Lambert, evaluates the direction and strength of price trends, allowing traders to decide whether to enter or exit a trade, refrain from entering a trade, or add to an existing position. When the indicator behaves in a specific way, it may be used to generate trade signals.

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Relative Strength

The relative strength index (RSI) is a technical analysis indicator that examines the size of recent price fluctuations to determine if a stock or other asset is overbought or oversold. The RSI is represented as an oscillator (a line graph that travels between two extremes) with a range of 0 to 100. J. Welles Wilder Jr. created this indicator and published it in his important 1978 book "New Concepts in Technical Trading Systems."

Values of 70 or above on the RSI, according to traditional interpretation and use, signals that investment is becoming overbought or overpriced, and may be ready for a trend reversal or corrective retreat in price.

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Volatility Indicators

The current implied volatility exhibited in a strip of S&P 500 Index options is reflected in Volatility Indicators, a statistic generated from options pricing.

Traders and analysts use a range of indicators to measure volatility and decide the best time to exit or enter transactions. While a great number of people panic during significant market changes, buying chances are created which provide outstanding trading ground for experienced investors. High volatility is typically a barrier for a hazardous investment.

Average True Range and Standard Deviation are examples of volatility indicators that may be quantified in a variety of ways.

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Average True Range

The average true range (ATR) is a market volatility indicator that requires technical analysis. It was developed by J. Welles Wilder. The indicator does not indicate a trend direction; rather, it measures the extent of price volatility. The average true range (ATR) is a market volatility indicator that displays the average price fluctuation of assets over time.

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Standard Deviation

The standard deviation is a statistical measure of market volatility that determines how far prices differ from the average. The standard deviation will produce a low number if prices trade in a small trading range, indicating little volatility. In contrast, if prices fluctuate drastically, standard deviation returns a high outcome, indicating extreme volatility.

As prices become more volatile, the standard deviation rises. As the price movement settles, the standard deviation decreases.

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Volume indicators

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Volume indicators are technical instruments used to assess the bull and bear strength of an asset. To ascertain which side is in charge of price activity, most analysts look at buying and selling pressure before executing a trade. The Volume Indicators show the percentage difference between two moving averages of a security's volume.

A support or resistance breach can be confirmed using Volume Indicators. A support breach on higher volume signals a greater move than a low volume support break. Similarly, a resistance break on rising volume indicates increased buying interest.

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Chaikin Oscillator

Named after its creator Marc Chaikin, the Chaikin Oscillator tracks the moving average convergence divergence (MACD) accumulation distribution line. Marc Chaikin uses the Chaikin Oscillator to track money flowing in and out of the market, correlating money flow to price action aids in the identification of peaks and bottoms in short and intermediate cycles. He recommends combining it with a 21-day price envelope and an overbought/oversold indicator (such as Momentum or RSI).

Chaikin Oscillator

On-balance Volume

The on-balance volume (OBV) is a technical analysis indicator intended to relate price and volume in the stock market. OBV is based on a cumulative total volume.

Chaikin Oscillator

Volume Rate of Change

The volume rate of change (VROC) is a technical indicator that quantifies the pace at which volume changes.

Volume is one of the most effective indicators available to day traders. It is a default indication on most charting systems and is accessible to almost everyone. The overall aggregate of the number of assets that changed hands is known as volume.

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Volume does not distinguish between assets that are purchased and sold separately but rather accounts for both.

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Learning Resources

Technical Analysis Books

Trading can be incredibly challenging for novices. It takes hours of effort each day to remain current on news, new tactics, and all of the necessary materials. Overall, it is not a task that can be accomplished in a week. Months, if not years, might pass. Even the most seasoned traders are always learning new things.

One of the most effective methods for traders to improve their abilities is to learn from the errors and successes of others. We have an article on the best trading books which can be of great help to those just starting out: Top 15 trading books

The trading books included in this article provide beginners as well as seasoned traders with a variety of viewpoints and tactics to help them earn from the currency market. These books apply to all financial markets and present an easy-to-understand introduction of how to use technical analysis patterns.

Chart patterns, trend lines, indicators, and support and resistance levels are all examples of technical analysis methods. Price charts are the major input for technical analysis in making trading choices. These books are a suitable and recommended way to start learning vocabulary and basic market analysis principles for new traders.

There are thousands of stages that people must complete to genuinely call themselves a trader. The knowledge gathered from these trading books may assist you to trade on a variety of platforms. The majority of these measures are made for persons who are trading for the first time or who are seeking to depart with some experience.

Technical Analysis courses

When it comes to Technical Analysis courses, novice traders have several options available to them. They can explore the markets through self-paced online courses.

Online courses offer some unique benefits as they are often designed and taught by professional traders so students have direct access to trading experts.

We have a course on technical analysis patterns on our course directory

After you've gained the confidence needed to start trading, you'll need to keep up with market trends, economic news, and worldwide events that might affect the market. You'll also want to keep honing your trading skills by studying how to execute better profitable transactions.

Fortunately, there is a wealth of knowledge available online, making it quite simple for both novice and expert traders to learn what they need to know with a little study.

Key Takeaways

Trading with technical analysis can be a hassle without proper guidance on how the financial market operates. Most traders lose huge sums of money and give up after a few weeks. Successful traders in this space make use of technical analysis and other technical indicators. Things to note:

  • Using technical analysis of price action along with technical indicators could increase your success rate.
  • Technical indicators give traders more confidence in a trade setup.
  • Technical indicators have varying results on different time frames, back testing helps traders get the most out of each indicator.
  • The financial market is very unpredictable, and things can go wrong at any time. Regardless of what your indicators say, always apply proper risk management.