Technical analysis

What is technical analysis, why is it needed and how to carry it out

Technical analysis starts with the price chart and is inextricably linked with it. Even a beginner first of all comes to mind to start peering intently at the trading platform in search of patterns. Oddly enough, they really are there. Graph is a kind of language, akin to the one in which mathematicians communicate. A professor of any country can easily figure out images of parabolas and universally written formulas.

It's the same with traders and analysts around the world. They have developed their own language, thanks to which they "read" trading signals and execute trades depending on their trading strategy. This is technical analysis.

Definition

Technical analysis is an attempt to calculate the market. It is based on mathematically processing the previous price values ​​and, based on them, make a forecast for the future movement.

Formulas, algorithms, indicators and levels help traders in this - in general, objects that interpret the quotes chart in one way or another. So it turns from a chaotic set of prices into a logically built structure. In the center of which is still man and his psychology.

How technical analysis appeared

People are both behind the creation and development of technical analysis. It all started with Charles Doe, one of the developers of the Dow Jones index. So, he identified three trends for price movement: upward, downward and flat. Also in the treasury of his discoveries is the theory of confirmation and refutation of price movements - by indicators. He was the first to mention how important it is to track the volume of transactions in the market and passed on forecasting techniques to his colleagues.

In addition, the youngest editor of the financial section of Forbes magazine, Richard Schabeker, made a significant contribution to the development of technical indicators. He also opened the eyes of the trading community to the importance of psychology in trading. Even when conducting this type of analysis as technical.

The purpose of technical analysis

Conducting a technical analysis of Forex or any other market means determining the current trend and confirming your forecasts regarding further price movement using various graphic tools. As a result of these manipulations - the determination of the right moment for the transaction.

Thus, the purpose of technical analysis is to see the rationale for opening a position on the chart itself.

Fundamentals of technical analysis

✔️ Everything is included in the price
It is important to understand how this particular quote is formed at a given second. Adherents of technical analysis say that all the news, all the tug-of-war of supply and demand, all the comments of regulators and the expectations of traders - everything is in the current price. It is necessary to understand this and enter the market with this understanding.

✔️ Price movement is subject to trends The
price does not change chaotically, but for certain reasons. The more explicit they are, the more visible they are to traders, investors and regulators. All of them are people, and therefore they are looking for opportunities for more profitable conclusion of deals. Therefore, as long as there is supply, they will buy, and as long as there is demand, they will sell. This is how trends are formed in the market.

✔️ The history of price dynamics repeats itself
Perhaps gravity or psychological patterns of human behavior are to blame. Conventionally, if everything is bad, traders sell. If everything is good, they buy. There is also a feedback loop: the price rises following the appearance of a buy signal, which is read by all traders. However, the modern world has begun to change so rapidly that recently, new market habits have been increasingly formed, which are extremely interesting to observe.

✔️ Technical analysis can be applied to any type of asset
There are more “technical” assets, and there are less “technical” ones, especially in the forex market. However, they all form trends, and their price is trying to find support during the descent and resistance (boiling point) - during the ascent.

Technical or fundamental analysis

When trying to choose between two types of analysis, choose both. There are irreplaceable moments in one, and vital moments in another. It is foolish to sit down to trade without checking the news release on the Economic Calendar. Equally, it is difficult to make a decision to open a deal without visually understanding whether it is “expensive” now or “cheap”. To do this, you need to make a comparison: overlay levels and indicators, which we will talk about in this article and other materials.

Types of graphs

Forex instrument prices change every second. As soon as a new quote arrives on the trading platform, it forms the basis of the chart. It is more convenient to monitor changes and analyze them using it.

Line chart

This type is only suitable for superficial analysis of the price movement in Forex. It simply connects the quotes coming to the platform with a broken line and allows you to see the movement as a whole. Globally, no granularity.

Candlestick chart

Each candlestick of this type of chart in Forex is made up of asset quotes for a certain period of time: the trader sets it in the chart settings independently. For example, you can see how the price has changed on minute intervals (M1), in intervals of 5/15/30 minutes (M5, M15, M30), hour (H1), 4 hours (H4), on daily (D1), weekly (W1) and monthly (MN) charts. Such charts are most often used by traders, because

candlesticks display a lot of information: ✔️   Price at the beginning of the period
✔️   Price at the close of the period
✔️   The highest price for the selected period
✔️   The lowest price for the selected period

One period = one candle.

Often, traders are interested not only in the trend (general rise or fall), but also its strength. In addition, traders often find patterns in combinations of several adjacent candles.

Bars

This type of charts contains the same information as a candlestick chart (open, close, high and low for the period), but has a slightly different appearance: a vertical bar with notches on the left (open level) and on the right (close). The top and bottom of the vertical bar mark the range of price fluctuations over the period. It is believed to be used frequently in Europe.

Line chart

This display is the easiest for novice traders to understand: all quotes are connected by a broken line.

However, for professional analysis, it is not enough just to see where the chart mostly goes: up or down. Therefore, this type is suitable only for a superficial study of the price movement, when you want to see it in its most general form - without nuances.

The main methods of technical analysis

✔️ Graphical - Price action
You look at the chart and try to find patterns   on it, into which Japanese candlesticks are added. Some of these patterns signal a price reversal, while others signal a trend continuation. There are also figures of uncertainty, when the asset itself does not yet know which way to go next.

✔️   Indicator - mathematical
You choose technical indicators on the trading platform: different lines, based on which calculations are made with the price based on previous quotes using different formulas. These indicators help to visually determine the best moments for opening trades (give signals) and the current assessment of the situation from the side of the trend life cycle.

✔️   Candlestick analysis
You analyze the Japanese candlesticks themselves: their close, open, length, as well as which candles are located on the sides. This method is similar to graphical analysis and is a more detailed version of it.

✔️ Volume   analysis
More transactions on the market - more volume of transactions and, therefore, more interest of traders in a particular asset. This factor proves the strength or weakness of the price trend. There are special indicators for determining volumes. The simplest and most accessible of them is the On Balance Volume (OBV) indicator. It connects the volume and the price change accompanying the given volume. If, when the price rises or falls, an increase in volumes is noted, this is considered a confirmation of the trend. If the indicator or volumes are falling, then there is no confirmation, and it can be dangerous to join the movement.

Trends

In order to make a decision to buy or sell an asset on Forex, you need to clearly understand which trend prevails on the chart. The trend line, a basic indicator of technical analysis, helps to determine this. Its main purpose is to "highlight" and emphasize the direction of price movement.

Before plotting this indicator, identify at least two major tops (highest points on the chart) or bottoms (lowest points) and then connect them using the Trend Line tool.

An uptrend is determined if both the maximum and minimum points of the chart are systematically increasing. Those. the price is gradually increasing.

When the price falls below the previous low during the downturn, we can talk about a trend reversal.

A downtrend is a sequence of increasingly lower highs and lows.

A sideways trend (flat) is defined when the tops or bottoms of the chart remain at approximately the same levels.

The importance of trend lines is that they help traders recognize the point at which price is more likely to move up or down.

When using this indicator to determine the direction of opening a trade, remember that the more confirmations of an upward (downward) move you see, the stronger it is.

Reversing a strong trend in Forex is more difficult than one that is just emerging.

Support and resistance levels

Unlike a trendline, support (bottom) and resistance (top) are always horizontal.

The resistance level is the clear upper border of the price channel, and the support level is its lower border.

Please note: all of the above is only valid for an uptrend.

When the price goes down, the situation is reversed: the level of the tops becomes the support, and the border, built on the lows, becomes the resistance.

As soon as the chart passes ("breaks through") one of the levels, it can be a strong signal for further movement within the impulse.

It also happens that it is impossible to establish unambiguous levels: then it is better to identify areas of support / resistance.

It is possible to plot support and resistance levels using the bodies or shadows of Japanese candlesticks, but it is more reliable to identify horizontal "zones". Their breakdown can already be regarded as a more reliable signal.

Channels

In technical analysis, there are also channels that are used to determine the direction of movement of the price of an asset and work according to the same laws as the levels of support / resistance. They additionally help to determine the points of entry and exit from the market and are divided into three types.

✔️   Ascending channel: each next high and low is higher than the previous one.
✔️   Descending channel: each next high and low is lower than the previous one.
✔️   Side channel: each next maximum and minimum is approximately at the level of the previous one.

Indicators

If lines and levels are the basic analytical tools of technical analysis, then indicators are the main ones. These are different lines (one, two or several at once) that are superimposed on the price chart (or appear below it). They are needed in order to help the trader understand what is happening on the market now.

There are the following groups of "Indicators":
✔️   Trend - help to determine the direction of price movement and are ineffective in a calm market;
✔️   Oscillators - indicators that demonstrate how much the price has deviated from its average value, and help both determine the periods of trend
reversal and help the trader dirty ✔️   Volumes - take into account the total number of buy and sell transactions for a specific asset;
✔️   Bill Williams - Developed by an outstanding mathematician and trader. In addition, in the terminal, in the "Navigator" tab of your trading platform, you will, for example, find Bill Williams' tools, the most popular of which is the Alligator.
✔️  psychological indicators - for the most part, refer to the previous point, since this, first of all, includes the theory of Elliott Waves (visualization of the phases of the behavior of the "crowd" in the market);

This division is very conditional: sometimes the same instrument falls into several groups. So, for example, MACD is considered a trending indicator that looks and works like an oscillator.

Trend indicators and oscillators

Let's get acquainted with two types of the most common trader's "helpers":
✔️   Trend indicators (lagging)
✔️   Oscillators (leading)

Trend indicators indicate the direction of the prevailing trend, while oscillators signal reversal points. They are based on a certain formula, which is automatically calculated in the trading terminal and demonstrates the results of these calculations in a visual graphical form.

It is believed that if you take into account the readings of several complementary instruments at once, you can get a clear picture of what is happening and build a reasonable forecast of price movement.

Trendlines are often used to confirm the presence of a trend and give a signal after the actual market reversal.

Oscillators are designed to give signals of a trend change even before direction has changed.

They measure the strength of the current price dynamics and note either:
✔️   that the momentum for the growth / decline of quotations has not yet dried up,
✔️   or that the movement has gone too far and a correction is likely (i.e., an inevitable price rollback in the opposite direction).

Stochastic

Stochastic is an indicator that gives the most accurate signals of overbought (when the price chart exits the level 80) and oversold (when the line breaks below level 20).

Select Stochastics Oscillator in your trading platform and set the following settings to get started: Period% K - 5, Period% D - 3, Slowdown - 3.

As soon as the indicator line enters neutral territory from the overbought / oversold area, look for a reversal candlestick pattern on the chart.

SMA, or Moving Average

The Simple Moving Average shows the average price of an asset, excluding minor fluctuations. The higher the value in the "Period" column you set when the indicator is superimposed on the chart in your trading platform, the more "smoothed" the SMA will be.

For example, a 15-period moving average on a 5-minute time frame will sum up the closing prices of the last fifteen 5-minute candles for you, and then divide that amount by 15.

A buy signal occurs when the price crosses the MA line from bottom to top.

A sell signal occurs when the price crosses the MA line from top to bottom.

In general, the Moving Average is a good filter for determining the trend and interpreting the movement of other, more complex indicators. However, please note that such a system, as a rule, is not used by traders as the main one.

For example, if the Stochastic (or other oscillator) rises above the moving average, the uptrend will continue. If the indicator falls below the MA, then this is considered a sign of the continued downward trend.

Shapes

Price charts often draw specific patterns called technical analysis charting patterns (or patterns).

Finding such patterns on a live chart can seem quite difficult at first glance. However, with experience you will learn to see which pattern is forming right now and make trading decisions based on this information.

There are two main types of chart patterns: continuation patterns (figures) and reversal patterns.

Continuation patterns show that the price of an asset will move in the same direction in the near future.

Reversal patterns, on the other hand, confirm that the price is about to reverse.