Introduction to technical analysis: basic postulates, types and indicators
Nowadays a huge flow of information is dumping a market participant and so that a trader does not drown in the ocean of data, a financial instrument such as technical analysis (TA) has been developed. In simple terms, technical analysis is the prediction of price changes in the future based on the analysis of price changes in the past.
Surely you will ask, “What does the analysis of price changes mean, why does the price change at all, and who is to blame?”. Responding to these questions, it is worth noting that the global market is not worth presenting only as a collection of stocks, currencies, securities and other assets. The market is about people first of all. Their behavior, mood, fear, greed, expectations, etc. affect the supply and demand, respectively, and price changes. All movements of the market are controlled only by a person, in turn, human behavior is subject to certain behavioral patterns and stereotypes, which means that human behavior can be predicted.
Technical analysis is on three tenets, the first of them says that history repeats itself. A human is a rather lazy being and if someone has created a trade model before him that makes a profit he will not reinvent the wheel. No wonder people say that laziness is the engine of progress. That means, traders react to similar situations in a similar way, and in this connection, a similar dynamics of price changes is formed.
The second postulate states that price is subject to trends. This means that it does not change chaotically, but moves along a certain trend. Therefore, by building a graph and discovering its birth, it is decent to make money. Any change in the price curve separately may be random, however, the totality of such changes during the time interval is to form a trend. This means that time series of prices can be divided into intervals, where price changes in one direction or another prevail.
If demand becomes higher than supply, an upward (bullish) trend will appear. If supply becomes higher than demand, downward (bearish) trend will be formed. Also, there is a horizontal or sideways trend (sometimes called flat or “no trend”). This trend is born under the condition that supply and demand balance.
The third postulate – the price takes into account everything. This postulate means that you should not spend time exploring the causes of price changes (whether economic, political or other factors) because if the price began to change, it already took into account any possible causes and factors. This means that the trader should focus on the study of prices and volume, and bring the most likely direction of market development.
Therefore, technical analysis is not the study of causes, but the dynamics of development. E.g. Millions of traders around the world who know the three main axioms of technical analysis looked at the price chart of a certain asset, took into account the experience of previous generations, which is the same for all of them, attached several tools to it, often classical ones (we will consider them later in this article) and decided that the price will go up. Then they buy a certain asset or stock, and since there are millions of such traders all over the planet, the increase in demand begins to push the price of a certain asset or stock up. Those who are faster and smarter fix a decent profit. Therefore, you should always be one step ahead of competitors and guess the price trend. But let us tell this in order.
Before you start to learn the classic TA tools, it’s worth exploring what the main trends are. In the markets there are three trends arising from the duration:
- Short-term (small) – the trend lasts less than one month
- Medium (secondary) – last for several months
- Long-term (primary) – lasts several years
It is important that all three trends are divided into phases.
The long-term trend includes the following phases: accumulation, rise/fall, and distribution. During the accumulation period, traders take positions. During the rise/fall most traders determine the emerging trend and rush to use it. During distribution, traders fix income and close positions, while trading activity decreases and the market goes down.
The primary trend is good for long-term investments and is very significant for large investors.
Secondary trend, this is a correction relative to the primary trend and can reduce the price change obtained during the primary trend. The direction of the secondary trend may differ from the primary one, or go against it.
The short-term trend is interesting only for private traders, dependent on various random news. Analyzing it with TA is very difficult. Thus, short trends are the most difficult to analyze and predict.
There are the following classic tools that are most often used the traders of global financial markets.
“Japanese candles”, perhaps, the most popular and accurately the oldest tool.
A “candle” contains a black or white body, and also includes upper and lower shadows. The upper and lower shadow marks show max. and min. cost for a certain time interval. The boundaries of the body show the price at the time of opening and closing deals.
When the price of a traded asset has increased – the body is white, its lower limit shows the opening price, the top – closing. When the prices of the traded asset have fallen – the body is black and its upper bound shows the opening price, the lower – the close.
Another popular tool in the trading environment is a line chart, which is a solid line that connects the closing prices. Market closing prices are important indicators for forecasting, but only for daily, weekly and monthly charts. This type of chart is not suitable for analyzing prices on Forex and futures markets.
The bar chart is a graph, compared to a linear one, more succinctly reflects what happened to the price of an asset over the time period.
Max. cost for a certain time (top of the bar), min. price (lower point), opening price (the bar on the left), closing price (the bar on the right) are displayed on bars.
Support and resistance lines are the basis of TA. Often, a line of resistance occurs when traders for some reason do not buy assets/stocks at higher prices. The support line is a mirror of the resistance line, in which case traders do not want to sell assets/stocks.
The channel is also the main component of TA. In trading, this tool is considered as a corridor where price movement between the lines occurs. The longer the price of a stock/asset remains in the channel, the more there is the possibility to exit to one of the sides. If there is a breakout of the resistance line on a bullish channel, then this is a signal to buy stocks. For a bearish channel, breaking through the resistance line is a signal for selling stocks.
When using TA, it is worth remembering that there are many different tools but they are based on the statement that the dynamics of price changes is determined by the psychology of behavior of market participants.
For successful work in world markets, special training seminars will help you understand where you can acquire fundamental knowledge, understand tools, and master technical analysis. With a properly structured approach to gaining knowledge and practical skills, you will surely have a positive result.