TECHNICAL ANALYSIS BASICS
Technical Analysis is one of the main tools in forecasting future market price movements
according to the study of historical price movements. Like any other forecasting
tool, for example population and weather forecasts, the future predictions can never
be 100% accurate. However this is a very useful tool in indicating what is the most
probable outcome and helps traders identify how prices may behave in the future.
Technical Analysis uses a wide range of charts to indicate price movement’s
overtime.
WHAT IS TECHNICAL ANALYSIS
- Head and Shoulders:
The Head and Shoulders formation is one of the most common reversal patterns. It
consists of a left shoulder, a head, and a right shoulder and a line draw as a neckline.
If there appears a formation where the prices break through the neckline and keep
on falling after forming the right shoulder, then it confirms the completion of
the Head and Shoulders pattern and prices should continue declining. This is known
as a Head and Shoulders Top formation. The Head and Shoulders Bottom formation is
simply the inverse of the Top and likewise indicates a change in trend and sentiment.
You can see below an example of a Head and Shoulders Top formation.
- The Double Top & Bottom
The Double Top is a common price pattern that appears towards the end of an existing
bullish (rising) market. It is formed in the shape of two consecutive peaks of approximately
the same price. In between the peaks there is a minimum price and it appears as
a so-called "valley". The price level of this minimum is called the neck line of
the formation. A reversal in trend is confirmed when the price falls below the neckline,
indicating that a further price decline is the most likely scenario. The Double
Bottom is the exact inverse of the Double Top and it appears towards the end of
an existing bear (declining) market.
THE POPULAR INDICATORS
Below is a brief description of some of the most popular technical indicators that
are used by traders worldwide on a daily basis:
- Average True Range (ATR) -:
This indicator is one of the key yardsticks used in measuring market volatility.
The ATR is based on the True Range which is most commonly measured according the
difference between the greatest high and the greatest low.
- Simple Moving Average (SMA) and Exponential Moving Average (EMA)
This SMA is the unweighted mean of the previous n data points while the EMA is an
indicator that applies weighting factors which decrease exponentially. These indicators
are used mainly for Time Series data in order to flatten short term fluctuations
and highlight longer term trends
- Bollinger Bands
This indicator was developed by John Bollinger and it is used to indicate relative
price levels and to measure the volatility of the market. Bollinger Bands consist
of the following components:
- A middle band which is most commonly the 20-period Simple Moving Average(MA)
- An upper band which is most commonly 2 times the 20-period Standard Deviation above
the middle band.
- A lower band which is most commonly 2 times the 20-period Standard Deviation below
the middle band.
Instead of using the simple moving average the exponential moving average may also
be used. Bollinger Bands are mostly used in comparing price action to the action
of other indicators and in pattern recognition. The way traders use Bollinger Bands
to determine entry and exit points in the market vary widely.
- The Moving Average Convergence/Divergence (MACD)
This indicator is the calculation of the difference between 2 exponential moving
averages (EMAs) closing prices. It is used by traders regularly in order to identify
strength, direction, momentum, and duration of the trend of a certain instrument
(currency, commodity or CFD).
- Relative Strength Index (RSI)
It is a price Oscillator used in indicating changes in price strength. The biggest
advantage of this indicator is that it is easy to interpret. The price monitoring
oscillator is shown as a basic graph which ranges from 0-100, with high and low
levels marked at 70 and 30 respectively. The RSI is most commonly used on a 14-day
time frame and any breach by the price of the high or low levels indicates stronger
momentum.
- Momentum
This indicator measures the overall rate of change of the price of an instrument
(currency, commodity or CFD). Traders use the Momentum indicator to measure the
volume of a market. The Momentum indicator remains positive during an uptrend and
negative during a downtrend. If the Momentum indicator shows an upward cross of
zero then it may be interpreted as a signal to buy, while a downward cross of zero
may be interpreted as a signal to sell. In addition the high or low of the indicator
shows the strength of the trend.
- Stochastics
There are different types of stochastic indicators depending on the time period
used (Fast or Slow). These indicators compare closing prices to the high and low
prices of an instrument during a certain period of time. Stochastic indicators provide
traders with a signal to act depending on convergence-divergence or crossover of
the different period stochastic s (Fast or Slow).
- Ichimoku Kinko Hyo
This indicator is an equilibrium chart and its Japanese name literally means "equilibrium
chart at a glance". It is normally referred to among traders just as Ichimoku. It
uses candlestick charting to improve the accuracy of forecasting price movements.
It does not only consider price action but also factors in time as a key element.