Studying your prospective market is vital whether you’re an investor, business owner, or trader. But if you’re new to the market-studying ecosystem, one buzzword that gets thrown around the most is ‘technical analysis.’
Table of Contents
Table of contents
However, unlike other buzzwords that may not hold much water, technical analysis is critical to success in stock, crypto, foreign exchange markets. The concept of technical analysis for stock and forex traders is similar to the trend analysis investors do.
These processes connect the dots backwards to find a pattern that predicts future possibilities. This is called ‘Charting.’ Furthermore, another factor common to trend analysis and technical analysis is that they deal directly with prices. Hence, we’ll refer to both trend analysis and technical analysis as chart technical analysis for this piece.
WHAT IS TECHNICAL ANALYSIS?
Chart technical analysis is designed to predict a security’s future price movement. Predicting this future potentiality is based on examining historical data – price and volume. Thanks to charting technical analysis, investors and traders understand the gap between intrinsic value and market price. Common examination concepts they may employ in cases like these are behavioral economics and statistical analysis.
You should note that investors don’t leverage insight from technical chart analysis in isolation. They combine with fundamental analysis before making decisions. Each analysis is complicated, especially if you’re new to the scene. You need all the knowledge you can get.
One of the most crucial elements to understand is the trendline if you do technical analysis.
TRENDLINES IN TECHNICAL ANALYSIS
Trendlines are used in visually identifying price movements and patterns. The straight lines extend from one price point to another (descending peaks or ascending troughs), depicting positive, negative, or neutral movements. Knowing how to draw trendlines is a critical skill to learn as an investor or trader. With a properly drawn trendline, identifying areas of resistance and support becomes easy.
When trendlines get angled up, it’s called an up trendline. In this case, the highs are higher, and the lows are higher. In the same vein, it’s called a down trendline when a trendline is angled down. In this case, the highs are lower and the lows lower.
Furthermore, as an investor, understand that trendlines differ. A significant determinant of the difference is the price bar between connected dots. Some people also draw their lines on closing prices, not highs and lows. Hence, it’s all about understanding your specific charting process and strategy.
A consensus, however, is that trendlines enjoy increased validity the more price points there are to connect. As simple as the trendlines seem, there are two vital sub-concepts. These are; reversal patterns and continuation patterns.
Continuation patterns occur when a price point chart depicts a temporary trend disruption. The concept of continuation pattern is sometimes called ‘a pause.’ During this period, investors in either the bull or bear market are taking a rest.
Owing to this, it is vital to pay attention to the chart trendlines. You should also pay attention to details like if the price at a particular point is above or below the continuation zone. The main theory of continuation patterns is that ‘every trend will continue until reversal is confirmed.
Summarily, continuation patterns are when price continues on its trend.
There are types of continuation patterns to note:
- Pennants: A pennant is formed when two trendlines to connect price points eventually converge. Beyond the characteristic convergence, the pennant trendlines travel in two directions.
- Flags: Flags are also formed by using two trendlines, which can have upward, sideways, or downward slopes. When flags form, subsequently, volume declines over a specific period.
- Wedges: Wedges have similarities with pennants – two converging lines are occurring. The difference between wedges and pennants is that the former’s trendlines move in the same direction. Wedges also have a similarity with flags – there is a subsequent volume reduction, which increases when the price goes out of the pattern.
Reversal patterns inform a situation where price patterns depict a directional change. For example, the reversal patterns indicate periods when the current market run (bull or bear) ends. At these moments, the trend that has been established so far heads in a new direction.
When reversal patterns occur at the top of the market, it’s called distribution patterns. In this case, there are more sales than the purchase of a particular entity. However, if reversal patterns occur at the market’s bottom, it’s called accumulation patterns. In this case, there is more purchase of trading entities than sales.
There are types of reversal patterns to note:
- Heads and Shoulders: This is a situation where there are two micro price shifts around a macro movement. The heads and shoulders situation can happen either at the market’s bottom or top. Heads and shoulder, most times, occur in three bouts. The first push is either a trough or a peak. Then, this activity is followed by a second one, which is always larger. Finally, the third head and shoulders activity is almost always similar to the first.
- Double Tops: This depicts a short-term swing high situation where the market has tried, twice, to break through a particular resistance level, but fails. The trendline from a double top always looks like the letter “M.” Double tops result in a trend reversal, following the two futile resistance break attempts.
- Double Bottom: This is similar to double tops. The double bottom is a short-term swing low situation where the market trend is trying to break below the same support level but fails. The double bottom scenario also results in a trend reversal.
APPROACHES TO CHART TECHNICAL ANALYSIS
Technical analysis has different strategies to explore. Each of these strategies has its perks and drawbacks. However, these strategies fall into two main categories: top-down and bottom-up approaches.
This is a macroeconomic analysis process where investors consider the whole economy before looking at individual securities. With this approach, the entire region’s economy is considered, followed by the sector the company is in, the economics, and the stocks of the company.
The top-down approach is most used when the investor or trader is after short-term gains.
The Bottom-up chart technical analysis approach focuses on the individual stocks or companies in question before shifting attention to the macro-economy. The bottom-up analysis looks to find potential entry and exit points. Value is of utmost importance to investors using the bottom-up approach to analysis; they seek long-term market presence.
TIPS ON MAXIMIZING YOUR CHART TECHNICAL ANALYSIS STRATEGY.
Several technical analysis strategies exist. To maximize any of these strategies, diligently follow these:
- Pick a strategy: As a trader or investor, don’t try to use all technical analysis strategies. Instead, it’s best to pick one strategy and reiterate it till mastery. As a beginner, one of the easiest strategies you can check is the moving average crossover strategy.
- Identifying Securities: Either you are looking to invest in stocks or a startup, picking your battles diligently is vital. Not all companies or stocks will fit your strategy. Either pick the entity that fits your strategy best or master another technical analysis strategy.
- Find the perfect brokerage: Ensure to have a trading account to support your chosen security.
- Track and Monitor: Your work doesn’t end at getting the right brokerage. You need to monitor the trades coming off your strategy. The strategy you choose determines how long you should remain vigilant.
- Use Software: Several investment analysis tools and software are ready to enhance your trading performance. Find one; you can’t be at your best all the time.
When making investment decisions, doing your due diligence on fundamental and technical analysis is pertinent. When you do concrete work with your chart technical analysis, you optimize your long-term positions and returns. However, dig deeper into specific strategies before committing to one. Do the work!