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Thursday, November 24, 2011

6 key elements of technical analysis


Today I want to talk about importance of technical analysis and various aspects of it that should help you in making profitable trading decisions. I know that most people want to know the fundamentals of economics, finance and see the big picture of how global economy works. However, we should understand that our perception and understanding of what we see in the world may be very subjective and if we make decisions (in trading) based on those subjective assumptions we might end up losing all of our capital. Therefore, I am more for doing technical analysis than I am for doing fundamental analysis. This does not mean you should not study fundamentals. It means you have to compare what you know with price action and follow the market, not your opinion. 

Even if your opinion is right about economy you should never forget that there are a lot of powers working in the market and they have enough capital to push the price where they want, no matter what state this or that economy is in at a given moment. This can have a very negative impact on your trades, especially if you are a short term trader. I saw a lot of times how good economic news is accepted very negatively by participants, or market makers I’d better say and prices start falling. So, if you follow your opinion you may be right and lose money, if you follow the market your fundamental opinion might be wrong, but you make money. So, that is a big plus for studying technical analysis. 

When you finish reading the post read other related articles and watch my videos:

Resistance




1. Resistance and support levels

I personally believe that resistance and support levels are the greatest tools of TA. These are levels where price comes and usually reverses. These levels are extremely important in range trading for when prices are stuck in ranges support and resistance levels are visited a lot of times and they do hold till finally a breakout occurs. One would wait for reversals around these levels and often be able to catch a new swing and go to the other end of the range making nice money. Patience and risk management is the key element here. 

2. Technical indicator

Technical indicators have been developed by a variety of trading specialists to help one in making trading decisions with the help of those indicators most of which are based on moving averages. The most popular indicators are: MACD, RSI, various moving averages, Stochastics, Bollinger Bands, Pivot points, Price channels and many more. I do not want to mention all of them, nor discuss them in detail as I do not believe you should base your trading decisions on those alone. Try to use them with other technical or fundamental analysis tools. My favorite indicators are MACD and RSI. I wrote posts on the usage of both of them as well as moving average indicator.  

3. Price action

It is a movement of a security in some direction and by using tools of technical analysis a trader is often able to guess the direction of price in advance. The application of those tools might be subjective as looking one and the same pattern two traders will probably form a different opinion. If one includes things such as fundamental news releases into one’s analysis his accuracy in predicting price action will grow. Most traders like looking at candlestick patterns, support and resistance levels and other methods to predict direction of price in the nearest future. No one will do it one hundred percent correctly all the time. Learning from mistakes and perfecting one’s methods of analysis should make one’s speculation better. 

4. Trading strategies

There are plenty of trading strategies that purely rely on application of technical analysis. If you visit sites like Forex factory, Babypips, dailyfx and many more you will find a lot of free trading strategies that are based on TA. Most are based on the application of technical indicators, some on breakout of support and resistance levels, others on news trading and many more. If you are a newbie you can visit one of the above mentioned sites and back test some of the strategies, which you will like most. 

5. Chart patterns

Those that like trading swings or trends that last longer than a week will often wait for developing chart patterns that would indicate a continuation of an existing trend, show a possibility of a break out of a current chart pattern, show places of a possible reversal and many more. The most famous chart patterns are: triangles, head and shoulders, inverted head and shoulders, wedges and rectangles. Some traders rely purely on those patterns while making their trading decisions and make big money in financial markets. One of them is Dan Zanger who made millions in stock market when it experienced dot.com bubble. He also pays much attention to volume, which is not very important if you are a Forex trader for you cannot know exact volumes if you are trading currencies. It is important if you are trading stocks though. 

6. Trends and swings

Predicting long term trends and swings is probably one of the best things that technical analysis can help you to do in trading securities. We know that securities tend to stay in ranges for a long time. Some say that the ratio is ten to one. It means that securities could be in ranges for about ten months in ranges a year and only two months trend. But if one wants to make consistent profits, one should also learn how to identify an emerging trend and trade in the direction of it. One of the best ways to do it is to identify the limits of a range (support and resistance levels) that a security is in at a given period of time and wait for those limits to be broken. That’s how a lot of traders of the past and present made millions of dollars. They also kept building a line of positions after the breakout and would exit all of them when they saw the slightest sign of reversal.
That much information about technical analysis. I hope to expand the post and add more information on the topic in the nearest future. 

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Disclaimer
Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.