Technical analysis definition:
analysis is the examination of past price movements to forecast future
price movements. Technical analysts are sometimes referred to as
chartists because they rely almost exclusively on charts for their
analysis is applicable to stocks, indices, commodities, futures or any
tradable instrument where the price is influenced by the forces of
supply and demand. Price refers to any combination of the open, high,
low or close for a given security over a specific timeframe. The time
frame can be based on intraday (tick, 5-minute, 15-minute or hourly),
daily, weekly or monthly price data and lasts for few hours or many
other words technical analysis is defined as the art of identifying a
trend reversal at a relatively early stage and riding on that trend
until the weight of the evidence shows or proves that the trend has
Price Discounts Everything:
This theorem is similar to the strong and semi-strong forms of market
efficiency. Technical analysts believe that the current price fully
reflects all available information. Because all information is already
reflected in the price, it represents the fair value and should form
the basis for analysis. After all, the market price reflects the sum
knowledge of all participants, including traders, investors, portfolio
managers, buy-side analysts, sell-side analysts, market strategist,
technical analysts, fundamental analysts and many others. It would be
folly to disagree with the price set by such an impressive array of
people with impeccable credentials. Technical analysis utilizes the
information captured by the price to interpret what the market is
saying with the purpose of forming a view on the future.
Prices Movements are not Totally Random:
Most technicians agree that prices trend. However, most technicians
also acknowledge that there are periods when prices do not trend. If
prices were always random, it would be extremely difficult to make
money using technical analysis.
technician believes that it is possible to identify a trend, invest or
trade based on the trend and make money as the trend unfolds. Because
technical analysis can be applied to many different timeframes, it is
possible to spot both short-term and long-term trends.
What is more Important than Why: A
technical analyst knows the price of everything, but the value of
nothing". Technicians, as technical analysts are called, are only
concerned with two things:
1. What is the current price?
2. What is the history of the price movement?
price is the end result of the battle between the forces of supply and
demand for the company's stock. The objective of analysis is to
forecast the direction of the future price. By focusing on price and
only price, technical analysis represents a direct approach.
Fundamentalists are concerned with why the price is what it is. For
technicians, the why portion of the equation is too broad and many
times the fundamental reasons given are highly suspected. Technicians
believe it is best to concentrate on what and never mind why. Why did
the price go up? It is simple, more buyers (demand) than sellers
(supply). After all, the value of any asset is only worth what someone
is willing to pay for it. Who needs to know why?
markets move in trends caused by the changing attitudes and
expectations of investors with regard to the business cycle, an
understanding of the historical relationships between certain price
averages and market indicators can be used to identify turning points.
No single indicator can ever be expected to signal all trend reversals,
so it is essential to use a number of them together to build up
chart represents a price chart and is a sequence of prices plotted over
a specific timeframe. In statistical terms, charts are referred to as
time series plots.
the chart, the y-axis (vertical axis) represents the price scale and
the x-axis (horizontal axis) represents the time scale. Prices are
plotted from left to right across the x-axis with the most recent plot
being the furthest right.
technical analysts and chartists use charts to analyze a wide array of
securities and forecast future price movements. The word "securities"
refers to any tradable financial instrument or quantifiable index such
as stocks, bonds, commodities, currencies, futures or market indices.
Any instrument with price data over a period of time can be used to
form a chart for analysis.
will be explaining the construction of line, bar, candlestick and point
& figure charts. Although there are other methods available, these
are four of the most popular methods for displaying price data.
line chart is one of the simplest charts. It is formed by plotting one
price point, usually the closing price of a security over a period of
time. Connecting the dots or price points over a period of time creates
investors and traders consider the closing level to be more important
than the open, high or low levels. By paying attention to only the
closing price, intraday swings can be ignored. Line charts are also
used when open, high and low data points are not available.
the most popular charting method is the bar chart. The high, low and
close values are required to form the price plot for each period of a
bar chart. The high and low are represented by the top and bottom of
the vertical bar and the close is the short horizontal line crossing
the vertical bar. On a daily chart, each bar represents the high, low
and close for a particular day. Weekly charts would have a bar for each
week based on Friday's close and the high and low for that week.
Candle stick chart
Originating in Japan
over 300 years ago, candlestick charts have become quite popular in
recent years. For a candlestick chart, the open, high, low and close
values are all required. A daily candlestick is based on the open
price, the intraday high and low, and the closing price. A weekly
candlestick is based on Monday's open, the weekly high-low range and
traders and investors believe that candlestick charts are easy to read,
especially the relationship between the open and the close values.
White (clear) candlesticks form when the close is higher than the open
and black (solid) candlesticks form when the close is lower than the
open. The white and black portion formed from the open and close values
is called the body (white body or black body). The lines above and
below are called shadows and represent the high and low.
Point & Figure Chart:
charting methods show all plot in one data point for each period of
time. No matter how much prices moved, each day or week is represented
by one point, bar or candlestick along the time scale. Even if the
price is unchanged from day to day or week to week, a dot, bar or
candlestick is plotted to mark the price action. Contrary to this
methodology, Point & Figure Charts are based solely on price
movements and do not take time into consideration. There is an x-axis
but it does not extend evenly across the chart.
beauty of Point & Figure Charts is their simplicity. Little or no
price movement is deemed irrelevant and therefore not duplicated on the
chart. Only price movements that exceed specified levels are recorded.
This focus on price movements makes it easier to identify support and
resistance levels, bullish breakouts and bearish breakdowns.
trend is a time measurement of the direction in price levels covering
different time span. There are many trends, but the three that are most
widely followed are:
is between 9 months and 2 years and is a reflection of investor's
attitude towards unfolding fundamentals in the business cycle. The
business cycle extended statistically from trough to trough
approximately 3.6 years, so it follows that rising and falling primary
trends (BULL and BEAR markets) lasts for 1 to 2 years. Since building
up takes longer than tearing down, bull markets generally last longer
than bear markets.
primary trend cycle is operative for bonds, equities and commodities.
Primary trends also apply to currencies, but since currencies reflect
investor's attitudes toward interrelationships among two different
who has looked at a price chart will notice that the prices do not move
in a straight line. A primary upswing is interrupted by several
reactions along the way. These countercyclical trends within the
confines of a primary bull market are known as intermediate price
movements. They last anywhere from 6 weeks to as long as 9 months,
sometimes even longer, but rarely shorter.
important to have an idea of the direction and maturity of the primary
trend, but an analysis of intermediate trend is also helpful for
improving success rates in trading, as well as for determining when the
primary movement may have run its course.
Short-term trends typically last from 2 to 4 weeks, sometimes shorter
and sometimes longer. They interrupt the course of the intermediate
cycle, just as the intermediate-term trend interrupts primary price
movements. Short-term trends are shown in the market cycle model as a
dotted line figures, they are usually influenced by random news events
and are far more difficult to identify then their intermediate or
analysis is built on the assumption that prices trend. Trendlines are
an important tool in technical analysis for both trend identification
and confirmation. A trendline is a straight line that connects two or
more price points and then extends into the future to act as a line of
support or resistance. Many of the principles applicable to support and
resistance levels can be applied to trendlines as well.
takes two or more points to draw a trendline. The more points used to
draw the trendline, the more validity attached to the support or
resistance level represented by the trendline. It can sometimes be
difficult to find more than 2 points from which to construct a
trendline. Even though trendlines are an important aspect of technical
analysis, it is not always possible to draw trendlines on every price
chart. Sometimes the lows or highs just don't match up and it is best
not to force the issue. The general rule in technical analysis is that
it takes two points to draw a trendline and the third point confirms
Ascending trend line
ascending trend line has a positive slope and is formed by connecting
two of more low points. The second low must be higher than the first
for the line to have a positive slope. Ascending trend lines act as
supports and indicate that net-demand (demand less supply) is
increasing even as the price rises. A rising price combined with
increasing demand is very bullish and shows a strong determination from
the buyers. As long as prices remain above the trendline, the upside
trend is considered solid and intact. A break below the upside trend
line indicates that net-demand has weakened and a change in trend.
Descending trend line
descending trend line has a negative slope and is formed by connecting
two or more high points. The second high must be lower than the first
for the line to have a negative slope. Downside trend lines act as
resistance and indicate that net-supply (supply less demand) is
increasing even as the price declines. A declining price combined with
increasing supply is very bearish and shows a strong resolve from the
sellers. As long as prices remain below the downside trendline, the
downtrend is considered solid and intact. A break above the downside
trend line indicates that net-supply is decreasing and a change of
trend could be imminent.
The Support and resistance:
represent key junctures where the forces of supply and demand meet. In
the financial markets, prices are driven by excessive supply (down) and
demand (up). Supply is synonymous with bearish, bears and selling.
Demand is synonymous with bullish, bulls and buying. These terms are
used interchangeably throughout this and other articles. As demand
increases, prices advance and as supply increases, prices decline. When
supply and demand are equal, prices move sideways as bulls and bears
battle it out for control.
The definition of the support
is the price level at which demand is thought to be strong enough to
prevent the price from declining further. The logic dictates that as
the price declines towards support and gets lower, buyers become more
tempted to buy and sellers become less tempted to sell. By the time the
price reaches the support level, it is believed that demand will
overcome supply and prevent the price from falling below the support
levels do not always hold and a break below support signals that the
bears have won out over the bulls. A decline below the support
indicates a new willingness to sell and/or a lack of incentive to buy.
Support breaks and new lows signal that sellers have reduced their
expectations and are willing to sell at even lower prices. In addition,
buyers could not be persuaded into buying until prices declined below
the support or below the previous low. Once a support is broken,
another support level will have to be established at a lower level.
The definition of the resistance
is the price level at which selling is thought to be strong enough to
prevent the price from rising further. The logic dictates that as the
price advances towards resistance, sellers become more tempted to sell
and buyers become less tempted to buy. By the time the price reaches
the resistance level, it is believed that supply will overcome demand
and prevent the price from rising above the resistance.
levels do not always hold and a break above a resistance signals that
the bulls have won out over the bears. A break above a resistance shows
a new willingness to buy and/or a lack of incentive to sell. Resistance
breaks and new highs indicate buyers have increased their expectations
and are willing to buy at even higher prices. In addition, sellers
could not be persuaded into selling until prices rise above the
resistance or above the previous high. Once a resistance is broken,
another resistance level will have to be established at a higher level.
Candle stick patterns
the 1600s, the Japanese developed a method of technical analysis to
analyze the price of rice contracts. This technique is called
candlestick charting. Candlestick charts are simply a new way of
looking at price; they don't involve any calculations.
charts are much more visually appealing than a standard two-dimensional
bar chart. As in a standard bar chart, there are four elements
necessary to construct a candlestick chart, the OPEN,HIGH, LOW and
CLOSING price for a given time period. Below are examples of
candlesticks and a definition for each candlestick component:
The body of the candlestick is called the real body, and represents the range between the open and closing prices.
black or filled-in body represents that the closing price during that
time period was lower than the opening price, (normally considered
bearish) and when the body is open or white, that means the closing
price was higher than the opening price (normally bullish).
thin vertical line above and/or below the real body is called the
upper/lower shadow, representing the high/low price extremes for the
period (one period of time measures the duration of selling or buying
within the market). As a trader, you can use any time period you want,
time intervals may be a tick chart, 1 min, 5min, 10 min, 1 hour, 4
hour, 1 day,…
Relative Strength Index (RSI):
index is a popular indicator for the Forex (FX) market. The RSI
measures the ratio of up-moves to down-moves and normalizes the
calculation so that the index is expressed in a range of 0-100. If the
RSI is 70 or greater then the instrument is seen as overbought (a
situation whereby prices have risen more than market expectations). An
RSI of 30 or less is taken as a signal that the instrument may be
oversold (a situation whereby prices have fallen more than market
is used to indicate overbought/oversold conditions on a scale 0-100%.
The indicator is based on the observation that in a strong upside
trend, closing prices for periods tend to be concentrated in the higher
part of the period’s range. Conversely, as prices fall in a strong
downside trend, closing prices tend to be near to the extreme low of
the period range.
Stochastic calculations produce two lines, %K
and %D which are used to indicate overbought/oversold areas of a chart.
Divergence between the stochastic lines and the price action of the
underlying instrument gives a powerful trading signal.
Moving Average Convergence Divergence (MACD):
indicator involves plotting two momentum lines. The MACD line is the
difference between two exponential moving averages and the signal or
trigger line which is an exponential moving average of the difference.
If the MACD and trigger lines cross, then this is taken as a signal
that a change in trend is likely.
Fibonacci number sequence (1, 1, 2, 3, 5, 8, 13, 21, 34…..) is
constructed by adding the first two numbers to determine the third n
umber that follows. The ratio of any number to the next larger number
is 62%, which is a popular Fibonacci retracement level. The inverse of
62%, which is 38%, is also used as a Fibonacci retracement level.
(Combined with the Elliott wave theory, see hereunder)
Gann was a stock and a commodity trader working in the 50’s who
reputedly made over $50 million in the markets. He made his fortune
using methods which he developed for trading instruments based on
relationships between price movement and time, known as time/price
equivalents. There is no easy explanation for Gann’s methods, but in
essence he used angles in charts to determine support and resistance
areas and predict the times of future trend changes. He also used lines
in charts to predict support and resistance areas.
Elliott wave theory:
Elliott wave theory is an approach to market analysis that is based on
repetitive wave patterns and the Fibonacci sequence. An ideal Elliott
wave patterns shows five advancing waves followed by three waves of
Gaps are spaces left on the bar chart where no trading has taken place.
An ascending gap is formed when the lowest price on a trading day is higher than the highest price of the previous day.
descending gap is formed when the highest price of the day is lower
than the lowest price of the prior day. An ascending gap is usually a
sign of market's strength, while a descending gap is a sign of market's
breakaway gap is a price gap that forms on the completion of an
important price pattern. It signals usually the beginning of an
important price move.
runaway gap is a price gap that usually occurs around the mid-point of
an important market trend. For that reason, it is also called a
An exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.
trend refers to the direction of prices. Rising peaks and troughs
constitute an upside trend; falling peaks and troughs constitute a
downside trend, that determines the steepness of the current trend. The
breaking of a trend line usually signals a trend reversal. A trading
range is characterized by horizontal peaks and troughs.
averages are used to smooth price information in order to confirm
trends and support and resistance levels. They are also useful in
deciding on a trading strategy particularly in futures trading or a
market with a strong upside or a downside trend.
moving averages, the price is averaged over a number of days. On each
successive day, the oldest price drops out of the average and is
replaced by the current price. Hence, it calculates the average for the
daily moves. Exponential and weighted moving averages use the same
technique but weight the figures-least weight to the oldest price, most
to the current.
Head and shoulders pattern:
A technical analysis term used to describe a chart formation in which represented by an instrument's price:
1. Rises to a peak and subsequently declines.
2. Then, the price rises above the former peak and again declines.
3. And finally, rises again, but not to the second peak, and declines once more.
The first and third peaks are shoulders, and the second peak forms the head.
head and shoulders reversal pattern forms after an upside trend, and
its completion marks a trend reversal. The pattern contains three
successive peaks with the middle peak (head) being the highest and the
two outside peaks (shoulders) being low and roughly equal. The lows of
each peak can be connected to form support, or a neckline.
Head and Shoulders Bottom (Reversal):
chart pattern used in technical analysis to predict the reversal of a
current downside trend, this pattern is identified when the price of a
security meets the following characteristics:
1. The price falls to a trough and then rises.
2. The price falls below the former trough and then rises again.
3. Finally, the price falls again, but not as far as the second trough.
the final trough is made, the price heads upward toward the resistance
found near the top of the previous troughs. Investors
typically enter into a long position when the price rises above the
resistance of the neckline. The first and third troughs are considered
shoulders, and the second peak forms the head.
head and shoulders bottom is sometimes referred to as an inverse head
and shoulders. The pattern shares many common characteristics with its
comparable partner, but relies more on volume patterns for confirmation.
a major reversal pattern, the head and shoulders bottom forms after a
downside trend, and its completion marks a change in trends. The
pattern contains three successive troughs with the middle trough (head)
being the deepest and the two outside troughs (shoulders) being
shallower. Ideally, the two shoulders would be equal in height and
width. The highs in the middle of the pattern can be connected to form
Double tops reversal:
term used in technical analysis to describe the rise of a stock, a
drop, another rise to the same level as the original rise, and finally
double top is a major reversal pattern that forms after an extended
uptrend. As its name implies, the pattern is made up of two consecutive
peaks that are roughly equal, with a moderate trough in between.
charting pattern used in technical analysis. It describes the drop of a
stock (or index), a rebound, another drop to the same (or similar)
level as the original drop, and finally another rebound.
double bottom is a major reversal pattern that forms after an extended
downside trend. As its name implies, the pattern is made up of two
consecutive troughs that are roughly equal, with a moderate peak in
A technical chart pattern composed of two converging lines connecting a series of peaks and troughs.
wedges indicate temporary interruptions of upward price rallies. Rising
wedges indicate interruptions of a falling price trend. Technical
analysts see a 'breakout' of this wedge pattern as either bullish (on a
breakout above the upper line) or bearish (on a breakout below the
technical analysis pattern created by drawing trendlines along a price
range that gets narrower over time because of lower tops and higher
bottoms. Variations of a triangle include ascending and descending
triangles. Triangles are very similar to wedges and pennants.
symmetrical triangle, which can also be referred to as a coil, usually
forms during a trend as a continuation pattern. The pattern contains at
least two lower highs and two higher lows. When these points are
connected, the lines converge as they are extended and the symmetrical
triangle takes shape. You could also think of it as a contracting
wedge, wide at the beginning and narrowing over time.
charting the price of an asset, this is the space on the chart between
an asset's support and resistance levels. The price of the asset will
stay within the support and resistance levels until a breakout occurs.
traders will buy an asset when its price is near the bottom of the
trading channel and sell it when the price gets closer to the top of
the trading channel, making a profit from the price spread. Trading
channels may be flat, ascending or descending