This is a Technical Analysis Plain and Simple Introduction
The challenge of presenting Technical Analysis to newcomers is that there are multiple elements to Technical Analysis and almost all of the resources make the assumption that the readership will not be automating the trading behavior. However, in this introduction, that assumption is removed and there is a different approach to charts that you probably have never encountered. Technical Analysis knowledge alone will not result in profitability, but portfolio management can ensure that conflicting and concurrent trades results in reduced risk and a stronger opportunity of being profitable in the short and long term.
Technical Analysis Explained (PDF document-free!) and boiled down.
What is Technical Analysis?
Technical Analysis is defined as the interpretation of a price chart for any financial instrument. It is used by many investors and traders to validate and determine trading entry and exit points. There are a spectrum of opinions surrounding the usage of Technical Analysis and the expansion of Technical Analysis factors has radically changed over time.
There are three main camps of thought concerning Technical Analysis:
- Anti-Technical Analysis: Prices are random and reflect all publicly available information.
- Combined Approach: Technical Analysis and News/Economic Data tell the full story.
- Charts Only Approach: The price conveys public and private information, which is all that is needed.
Technical Analysis Data Points
The elements of the price, time frame and volume inspire charts and indicators of all kinds.
- Time Frame of the Chart
- Historical Period of the Data Point Collected
- Volume Traded
This is what is generated on a time-oriented chart. There are tick-oriented charts that generate bars or candles without regard to time, but rather generate after a set number of trades. However, with these tick charts there are still the same parameters as a time-oriented chart with the exception of Time Frame of the Chart, which is replaced by a number of trades that are placed to generate a bar or candle.
The New Technical Analysis Data Points
The elements of Price, Volume and Time are not enough in this new era of data. Other sentiments that are outside of the news, economic data, and economic sentiments are in demand. Everyone is looking for any sort of an edge in this market, a leading indicator. Here are some of the new data points that people are using or are trying to find a way to use:
- Social Media: Twitter, Facebook, StockTwits
- Real Estate Market Sites: Zillow, Fincaraiz, etc.
- Fast Food Restaurant Pricing (Comparison pricing)
- Competitive Web Traffic Data
- Pay-Per-Click Advertising Rates
Unconventional ways to figure out the sentiments in a particular market, make comparisons, and use as a leading indicator. In an API-centric world full of web scrapers, this data can be collected and used to make investment decisions.
More often than not, these new data points are often inserted into indicators that are proprietary and used for the sole purposes of enriching the developer.
Now that you know what goes into the charts (the inputs), let's understand the different categories of outputs found on a chart.
Candlesticks or Bars
These are illustrations of the Open, High, Low, Close for each segment of time or number of trades dictated by the time frame of your choice. These candlesticks or bars tell traders the behavior of the market during the specific period of time. The shape, size and color of the candlesticks or bars can express that the market sentiment is going to reverse, continue or stall.
The color of the candlestick body is determined by the relationship between the Open and Close Price. This can be set to any color, but if the Open Price is greater than the Close Price, the candle will be one color and if the opposite is the case, then the candle will be a different color.
An individual candlestick will not necessarily tell the story, but rather it requires context.
Candlestick Patterns are what is formed when examining past candlesticks along with the current candlestick. This is an easily tested form of Technical Analysis within any software language (it can be used as part of the MT4 API too when doing Technical Analysis in Python, if you wish). These patterns are associated with different confidence levels, trends, and sentiment.
These Candlestick Patterns can be combined with other forms of Technical Analysis (using multiple timeframes too!).
These Candlestick Patterns appear on a shorter term basis than the patterns in the next segment
These form over the course of a much longer period of time than Candlestick Patterns. These patterns appear on all timeframes and there are two types of Chart Patterns:
- Visual Chart Patterns
- Harmonic Chart Patterns
The Visual Chart Patterns are clear from viewing them as the actual chart activity matches with the name of the Chart Pattern.
Above is a Rounded Bottom Chart Pattern, it is a rather obvious that there is a rounded bottom effect to the chart that would indicate that the price will rise above where the Chart Pattern originated. It is in this case a Bullish Chart Pattern.
Chart Patterns often have a better track record than Candlestick Patterns, but there are a few downsides:
- The visual element makes it extremely subjective, which means that even when coding the pattern to be detected there are challenges as the code can interpret things differently than an individual or several individuals.
- They are infrequent.
- They fail too and require trading safeguards to ensure that the fake breakouts are detected.
- Unclear exit and entry.
- They do not tell the entire story.
- Some chart patterns are more accurate than others.
Harmonic Chart Patterns are not as obvious in terms of shape. These use Fibonacci numbers to determine their shapes. The good news is that there are indicators that show these patterns like the Gartley, Bat, Crab, and Cipher. The other good news is that the indicators are able to be used in algorithms, which mean that they can be easily part of an automated trading strategy.
The downside with these patterns are the same as what plague the Visual Chart Patterns. However, these are extended patterns that provide more opportunities to place trades or validate other patterns.
Above is a Bearish Gartley, which probably would not be noticeable on its own.
Support and Resistance
Support and Resistance is the analysis of price levels based on past pricing. Support Levels are areas that either provide friction or reverse downward movement of price. Resistance Levels are areas that either provide friction or reverse upward movement of price. Not all Support and Resistance Levels are equal.
Resistance Levels become Support Levels when the price rises above them and Support Levels often become Resistance Levels when the price falls below them.
There are different types of Support and Resistance:
- Support and Resistance Levels based on past pricing as mentioned.
- Supply and Demand Zones
- Fibonacci Retracement and Extension Levels
- Pivot Point Levels
Supply and Demand Zones
This is a concept that is closely related to Support and Resistance, but it is predicated on a dramatic price move at a previous time.
Supply Zones are zones that provide resistance to upward bound prices and opportunities to reverse in price.
Demand Zones are zones that provide support to downward bound prices and opportunities to reverse in price.
These zones are usually determined in size by the candle body (or bodies) range before a breakout candle. However, when there are candles with overly large wicks and the price reverses itself, these wicks become Supply and Demand Zones. When the price enters these zones after their formation, the price is likely (based on the theory of supply and demand zones) to reverse in some way.
The downside to Supply and Demand Zones is that it is subjective in terms of the rules that the user wants to implement. What counts and does not count depends upon the individual creating the zones, some offer more flexibility in terms of what qualifies and others are more rigid.
The good news is that there are indicators that help you see these levels and then you can incorporate them into your algorithm.
Fibonacci Retracement and Extension Levels
Do you need to necessarily know what Fibonacci numbers and sequences are? No. There are indicators to incorporate into algorithms and chart objects that come with every platform to visualize it if you want to get an understanding of what they look like.
These levels serve as psychological support and resistance levels. They are derived from the previous Peak to Trough or Trough to Peak once it is clear that both ends are established and will not be replaced in the interim.
The downside is that these levels can be a bit messy in terms of trusting them and the Peak to Trough can seem a bit arbitrary based on the timeframe. Technical Analysis using Multiple Timeframes (not the PDF book), but rather the usage of Multiple Timeframes with Fibonacci Retracement and Extension Levels can create contradictions. Assuming that the price will rise or respect the levels like it is a self-fulfilling prophecy would be a critical mistake.
Pivot Point Support and Resistance Levels
These are pre-determined levels that are calculated on a daily basis. They are the same regardless of the time frame.
The levels are in visual order on a chart:
- Resistance 3
- Resistance 2
- Resistance 1
- Pivot Point
- Support 1
- Support 2
- Support 3
The Green Line is the Pivot Point, the Blue Line is Support Level 1, and the Red Line is Resistance Level 1 in the above image.
This is a good choice of a Support and Resistance Levels indicator for timeframes between 5 minutes and 1 Hour.
How are chart indicators derived? From the same elements everything else is associated. Price, volume, and time.
These chart indicators are printed over the candles on the chart, they are associated with the Trend - at least according to MetaTrader software.
Examples of these indicators:
- Ichimoku Kinko Hyo
- Moving Averages
- Bollinger Bands
- Zig Zag - This is the foundation of some other indicators.
Above is a 5 Minute USDJPY chart with Zig Zag (red) and Bollinger Bands (Blue).
All of these indicators can be incorporated into your algorithms, which is a recurring theme. They are all lagging indicators, which means that they will miss opportunities and possibly cause entries and exits to be triggered too late.
These are indicators that are found in the separate window of your charting platform. They measure different things from volatility to the oversold/overbought nature of the markets. There are many of these oscillators.
Examples of oscillators:
- Relative Strength Index
- Average True Range
- Standard Deviation
- Awesome Oscillator
These oscillators provide opportunities to trade divergences between the oscillator's position and the price. They also provide a picture into the nature of the market, but they are also rather dicey as well. Oscillators like all indicators are not perfect at all. These are lagging indicators, which they are acting upon old information.
These are the forms of Technical Analysis out there.
No, you don't need to pay for a Technical Analysis PDF eBook or a Technical Analysis webinar. The information is all readily available for FREE. Technical Analysis trades are not done based on feel and practice, but rather are coded, backtested and forward tested to ensure that the trades executed as they should and the strategy's track record results in profits.
There are too many snake oil salesmen selling courses and there are too few traders using multiple strategies in a portfolio that fits them. Yes, some of those strategies may come from other traders too. It is encouraged to diversify your holdings across fund managers even if one of them is yourself.