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Technical Analysis for Beginners
Saturday, February 4, 2020
- Technical Analysis
Most beginning traders and many accomplished investors are not exactly sure what technical analysis is. Or how to apply technical analysis and indicators and oscillators into their trading strategy. In this class begin with the understanding of charts and how these become the roadmap of an assets movement. We will then look at applying basic technical information to a chart, starting with a trend line and then adding support and resistance. Finally, we will go review some of the most popular indicators and oscillators such as Gann Fans, MACD and RSI as we build our roadmap to success.
The Director of Investors Trading Academy as well as a published author and educator. Barry brings with him over 35 years of financial market knowledge and experience. He holds an MBA in Finance and Economics from UCLA and an undergraduate degree in Economics from the University of Maryland. Barry was award the title of “Best Education in Europe” by Global Banking & Finance. Barry is also a presenter for the MoneyShow and many well-known news sources.
Technical Analysis and Charting for Beginners
You probably have heard of this technical analysis which shows you patterns and gives you indicators to predict the next price move in a security. If you have heard of this, I am sure you asked yourself (like most people): does technical analysis really work. I will try to help you answer this question, elaborate what it is and how it should be used.
What is Technical Analysis?
Technical analysis is based on three statements:
- History repeats itself
- People behave in patterns/Prices move in trends
- The Market discounts everything
Therefore, followers of technical analysis believe that in stock prices certain patterns are developed and trends are formed. These patterns (after the first statement) then tend to repeat themselves. So basically it is all about spotting this pattern/trend and hopping into it at the right moment. To help identify these patterns specific charts were created. Due to the third statement followers of technical analysis often solely rely on these charts and act from charts only. This statement tells that the current price of any security discounts everything (news, companies performance etc.) and is, therefore ‘correct’. Followers of technical analysis often use many different kinds of charts and draw special signal-lines on them. This process is called charting.
Basics of Technical Analysis
Here I will cover some of the basics of technical analysis. Let’s start with Trends.
A typical down trend
There are three possible forms of trends: an uptrend, a downtrend and a sideways trend/no trend. An uptrend is rising prices and is characterized by higher highs and higher lows. The opposite is the case for a downtrend (lower lows, lower highs). No trend or a sideways trend is where there is uncertainty in the market and therefore no real and clear directional moves.
A very important instrument in technical analysis are support and resistance lines.
Down Trend: Lower Line (Support) Upper Line (Resistance)
These normally make trends and other patterns much better visible. The support line is created by connecting the lows and the resistance line is created by connecting the highs of a trend. Support and resistance lines normally show areas which are hard for the price to get through.
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A breakthrough through one of these lines often counts as a signal for trend reversals. The two lines create a channel. This channel can have many different forms depending on the support/resistance lines.
One of the more common used charts (mostly by beginners) is the line chart. This probably is the most well-known and basic form of chart, nothing fancy here. The chart is created by connecting all the closing prices for a given security over a certain period of time. This is also the chart where there is the least given information. This chart often is used to give a cleaner and less distracting view of the price movement.
The next chart is probably the most used chart for more-advanced traders. The candlestick chart.
This chart offers a little more insight into trading activity than the line chart. The green candlesticks represent an up day, where the price closed higher than it opened. The red ones indicate a down day. The thin black line indicates the high and the low of a certain amount of time. The thicker red/green parts show the open and the close of a certain time. Usually, one candlestick indicates a day of trading.
These are the two most widely used charts which in my opinion really offer enough information for a single chart.
Indicators are supposed to indicate trend reversals or trend continuations. Some indicators are placed on the actual price chart itself and some have their own separate box for themselves. There are countless different indicators. It would be impossible for me to even list half of them. Therefore, I will try to list some of the most common and most used ones here.
Moving averages are smoothed out versions of the price charts themselves. They are normally placed on the price chart itself. As for every indicator, there are many different variations of this indicator. Regarding the time frame of the average prices, the most used settings (for longer-term investors) are the 200 day/100 day and 50 day moving average. Many people even use two different types of time settings to try to find up-building momentum. Otherwise, there are two different types of moving averages. There is the simple moving average (sma) and the exponential moving average (ema). The ema is an exponential moving (stretched) version of the sma. The sma is more commonly used, but many investors use both of them at the same time.
A crossover of two moving averages can sometimes be a signal for a trend reversal.
Moving Average Convergence Divergence (MACD)
If you ever read about indicators, you probably heard of this one. The MACD is one of the most well-known and most used indicators. This indicator is a momentum and trend-following indicator. It consists of two lines which both are special kinds of moving averages. The shorter moving average is called the signal line which should be used as a trigger for buy and sell signals. Different line-ups of the two lines are supposed to show overbought and oversold conditions of a security.
Relative Strength Index (RSI)
RSI is an indicator which is set up between 0 and 100. With default settings, there are straight lines at 30 and at 70. These indicate the overbought and oversold areas. An RSI above 70 signals overbought conditions and a RSI under 30 indicates oversold conditions. The line in the middle is sometimes used as a buy/sell signal line.
Patterns are certain formations in the price chart. Different patterns indicate different conditions and can offer different types of signals. I will try to give you some ideas of some patterns. But I won’t go very deep into this topic. There are a few simplified examples of some different patterns below. (Most of them can be turned upside down to create another pattern.)
The Problem with Technical Analysis
I think technical analysis can be great and helpful for many traders. But I think there are some problems with it as well. For the first part, I think some areas of technical analysis are just completely subjective, for instance, patterns. There are so many different weird formations in stock charts, but there seldom is a perfect pattern. Therefore, you have to interpret some of these patterns and these interpretations are completely subjective. The patterns which you see often aren’t the same patterns which I or someone else can identify. The same counts for support and resistance lines. You can draw them however you want. On most charts, there are at least three different ways to draw these lines.
Another problem with technical analysis is that too many people, especially beginners focus too much on it. It doesn’t help to look at 20 different indicators, patterns etc. This just confuses people because there will never be a scenario where all indicators and patterns will be in indicating the same.
So should you use Technical Analysis? If yes how should you use it?
Even though I’m not the greatest fan of technical analysis, it is a good tool to help you on decisions. But it really shouldn’t be more. You should never solely rely on any indicator and make a trade purely because of a signal of some kind. If you want to use technical analysis for your trading, I would suggest choosing max 4 indicators to help you make a directional decision. You should use them in conjunction with each other, so the majority of them should point in the same direction.
Technical Analysis for Options
Technical analysis is rather unimportant when trading options. What you should be looking at much more would be your option chain with implied volatility, some Greeks, the probability of ITM etc. Especially for the trading strategy I am teaching here (learn more here), technical analysis shouldn’t play a very big role. Nevertheless, you can use it as a small helper for some directional assumptions
If you are interested in charting and technical analysis you can try out TradingView. Tradingview is a very good charting platform. Check out my review here.
6 Replies to “Technical Analysis and Charting for Beginners”
Thanks for sharing about technical analysis. I have been into trading before and the main problem I faced was about overcoming my own emotions. Despite I know that a trade was going against me, I ignored all rational and took on the ‘gambler’ approach. Trading can be profitable and are adopted by people to earn a full time income. However managing emotions and expectations can be a difficult process to master.
Hey Leo, you are right! Not letting emotions influence any decisions while trading is extremely important.
I will be publishing another article on this topic very soon
Great post. This is a very clear explanation of technical analysis and how to use it. I specifically like your insight on patterns. The point you made about pattern formations being subjective is 100% correct. I feel as though some traders will look at a chart for so long and see a pattern that does not exist. If you cannot see a pattern instantly when looking at a chart, then it doesn’t exist. And you are also correct about looking at a bunch of different indicators, doesn’t help. Pick a couple of indicators only and use those for your trading. What specific indicators are your favorite?
Thanks for your comment. Seems like you really understand what I am talking about.
As I said in the end I don’t really use technical analysis in trading. But the seldom times when I do I try to look at indicators like RSI and Ultimate Oscillator sometimes some others.
I’m developing a fully automated robot trading software, that trades all the best opportunities from the stocks Dax market.
At this stage I am building the knowledge base based on facts and rules.
I am a programmer who knows nothing about trading, but with the help of experts, I am building my knowledge base.
I trade chart patterns Bullish flag, Cup with handle, Inverse head and shoulders… (*1) like Tim Grittani, Tom bulkowski, William O’Neal, Dan Zanger, Mark Minervini…
Experts say to use moving averages to improve performance.
My period of analysis is 17 years, I need to cover several cycles.
I work with 25 tickers from Dax, a liquid market with low commissions.
Take profit average: 3.62
Stop loss average: 3.06 (Win/Loss 1.18)
Maximum take profit: 11.5
Maximum stop loss: 6.5 (Win/Loss 1.77)
Experts say the optimal ratio of wins to losses shoulde be 2:1 !
My time stop is 7 days !
Experts say not risk per transaction more than 2% of total capital !
I found 425 Bullish Flag patterns in 17 years, for 25 tickers (*2) !
Experts say that 30 trades is a minimum to suggest statistical significance !
First result: if I trade 35 times a year, I get an average year profit of 37.82% (*3), deducting commissions from the broker!
Questions for the expert:
(*1) Is this a profitable strategy ? Do you work with another strategy more profitable ?
This is profitable but you work with another pattern ?
(*2) Is this value statistically significant ?
(*3) Taking into account the results of professional trader, is this first result a low, medium ou high value ?
AI programming student
I have practically zero experience with algorithmic trading and thus I can’t really compare your strategy to others. But almost 38% per year isn’t a bad average rerun at all. But just like with all strategies, you don’t know if the strategy will still be profitable in the future. If I were you, you should not only look at the average win, win/loss ratio… but also look at the biggest loss, the performance during financial crisis (e.g. 208) and more. We had an incredible bull market in the past few years which could have influenced your returns significantly, so compare the stats from then to past times, where the overall market wasn’t that stable.
But again, I have barely any experience with this kind of trading, so I can’t really help you too much.
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TECHNICAL ANALYSIS BASICS FOR BEGINNERS
“Technical analysis may appear complicated on the surface, but it boils down to an analysis of supply and demand in the market to determine where the price trend is headed.” — Investopedia
Technical Analysis the study of the markets action, a school of thought, a particular way of thinking, strategizing that starts with charts that shows price and trading volume history. It looks at the price movement of a company and uses its information and data to predict the future price movements.
Based on Three Presumptions:
- They discard the need for fundamentals based on Efficient Market Hypothesis (EMH);
- Price moves in Trends;
- History repeats Itself;
Users do not believe there’s a reason to study a company’s statements, as fundamental analysis do, since the stock price or market cap already includes all relevant information. Instead they focus on analyzing the chart itself for clues into where the price may be headed.
It has a fast approach prediction and conclusion usually in weeks, days even hours or minutes. As in opposed to Fundamental Analysis that could take years.
The main goal is to identify short to medium term trades where they will be able to take advantage of the market and trade successfully.
Technical Analysis uses historical price and volume to attempt predictions, based on human psychology.
Human behavior in the market creates a pattern and has been used for hundreds of years in Japan, where this technique first started.
Japan has used this technique since 1600’s when a guy named Hamna started with this analysis to identify trends or patterns in human behavior while trading rice. And it only became popular in the Americas in the 1970’s.
Sure, enough Hamna became very successful in his industry, tracking human behavior to identify if there is Fear (awareness of danger) or Greed (Excessive desire) in the market. Keeping the users of this technique ahead in the game, knowing when to buy or drop-out.
Critics of the Technical Analysis view this technique as unproven as a game of luck. Even though the strategy has proven itself for hundreds of years.
Human Psychology has remained as trackable as always, because we react in masses, it doesn’t
matter the market, human behavior still gives away patterns and that will never change.
Chart Patterns establish definition and criteria.
There are two major patterns to look for when identifying price patterns using trendlines: Reversing patterns and continuation patterns.
Reversal patterns suggests that a prior trend will reverse upon completion of the pattern. Reversals indicates that a trend will change in direction which can be good or bad against prevailing trend. There are several different reversal patterns you can study: Spike, Double Tops and Bottoms, Triple Tops and Bottoms, Head and Shoulders, Inverse Head and Shoulders.
Continuation patterns suggests that a trend will continue even once the pattern is complete. There are several ways to identify continuation patterns you can study: triangles, pennants, flags, rectangles.
A trendline is a line drawn over pivot highs and under pivots lows to show prevailing direction of the price. Trendlines show support and resistance in the time frame.
They also show direction and speed of price describing patterns during price contraction or decline in a business cycle.
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Topics Covered In The Package
- Dows Theory – The 5 tenets of trading
- Types of Charts – Line & Candles
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