Technical Analysis in Trading

Introduction

Within forex if you want to get far as a trader then you’ll have to use whatever you can at your disposal to ease that journey and sometimes instead of an indicator or any other trading tool your performance can depend a lot on how you analyze certain stuff too.

Definition of Technical Analysis

Technical analysis is simply a method of assessing statistical trends within trading activity which usually involves volume and price movement and is used to help determine trading or investment opportunities.

Historical context and development

Now technical analysis is by no means a new thing as it’s very old with its first aspects appearing as far back as the 17th century or perhaps even before!

The thing is we don’t fully know when exactly it began to take shape as a concept but in Asia it’s said to be developed during the 18th century by Homma Munehisa which then later evolved into various candlestick techniques.

So you can see that its principles are derived from hundreds of years worth of financial market data!

Importance in modern trading

Now just because it’s old that doesn’t mean that it wont fit within a modern setting and believe it or not its impact cannot be understated.

After all history can repeat itself and with the analyzation of past trends or trading activity you could reasonably gauge a picture of future trends or at least that’s the assumption or belief underlying this type of analysis here.

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Fundamental Principles of Technical Analysis

Besides the definition that we went over earlier there’s a lot that encompasses technical analysis as we’ll look at below.

The Dow Theory

Starting off with the Dow Theory which is based on the identification and confirmation of a trend and even now it’s widely used by all manner of technical analysts.

According to the Dow Theory basically a trend is said to be in place where it breaches the prior bottom or top in succession which then means that a higher bottom and a higher high are created if it’s a bullish trend but a lower high with a lower bottom in case of a bearish trend.

Market trends and their significance

So market trends are another important principle in technical analysis as you must have understood by now.

By identifying trends you can align your strategies accordingly and take advantage of potentially lucrative opportunities.

Support and resistance levels

Support and resistance levels are another thing within technical analysis and finding them out is very important but what even are they you might be wondering?

Well support levels are usually where you see the price stop falling and then bouncing back up whereas resistance levels are when prices normally stop rising to then dip back down.

Volume and its role in technical analysis

Volume analysis is basically the examination of how many times a share or a contract has been traded over any given period  and its widely used by many technical analysts as a way to make more informed trading decisions.

Key Tools and Indicators

There should be quite a number of tools that you can use to further your technical analysis and these come in the form of charts, oscillators, moving averages and even trend indicators.

Chart types (candlestick, bar, line)

For the chart types you have the main ones that people tend to use like line, bar and candlesticks.

Each chart has some unique patterns associated with it that you might want to look into.

Moving averages (simple, exponential, weighted)

Then you have  those typical moving averages which are based around finding the median of every price over certain time periods though the EMA and WMA variants tend to place more emphasis on the latest data points.

Oscillators (RSI, Stochastic, MACD)

Oscillators like the RSI, MACD or Stochastic show whether a stock is overbought and oversold and those are usually determined by looking at the price which should fit in quite well with your technical analysis goals.

Trend indicators (ADX, Parabolic SAR)

Then there are indicators that focus more on the trend side of things and aim to give a clear representation of up and down trends and these can include the ADX, the Parabolic SAR and more.

Chart Patterns

Over time if you analyze those charts for long enough you may start to notice certain patterns associated with significant changes in price and there are plenty of such patterns for you to look into.

Continuation patterns (triangles, flags, pennants)

Sometimes it’s good to know whether a trend is continuing or not; it doesnt matter if its down or up and there are patterns for those depending on what chart you’re using and these are flags, pennants and triangles that you could consider searching more about.

Reversal patterns (head and shoulders, double top/bottom)

Reversals have to do with a significant shift in current trends and these can include either bullish or bearish reversals.

Popular chart patterns for those include the double top/bottom and heads and shoulders.

Candlestick patterns (doji, engulfing, hammer)

Candlestick charts can be a very interesting choice to include in your arsenal as they provide some really good patterns like the engulfing, doji and the hammer which can help you make some really informed decisions.

This is because you’ll have a decent understanding of what’s going on in the market if you use it.

Technical Analysis Strategies

There are some strategies that are specific to technical analysis that you might want to know about which we’ll be looking at here, namely trend following, range trading, breakout trading and swing trading.

Trend following strategies

Trend following basically has to do with you trading along those up and down trends and trying to make the most from your positions by entering and exiting at the precise times.

Range trading strategies

Markets usually trend around 30% of the time and this fact alone means that traders cant really rely solely on capturing those big moves, as a lot of the time those markets tend to be range bound or trade within a range of sorts.

But if you want to range trade you will need to select a range that you believe the stock will stick to or trade in like $45 and $50.

So you could buy at $45 and then sell at $50 once it does hit that and keep doing it constantly until you feel that the range is no longer applicable.

Breakout trading

Breakouts have to do with the price breaking through known levels of support or resistance and any trading that occurs during that is basically breakout trading.

So identifying them isn’t exactly all that common but once you do ideally you’d want to enter a long position once it starts and then enter a short position once you feel that the breakout has stopped or wont carry on anymore.

Swing trading using technical analysis

Swing trading has to do with medium to long term gains so naturally if you’re a swing trader and technical analysis is something that tend to prefer more then you can start by simply adjusting the time frames to better reflect your goals.

Try increasing or decreasing those look back periods depending on the type of stock and what best suits it.

Advanced Technical Analysis Concepts

Let’s look at some of the more advanced stuff now which has to do with technical analysis.

Fibonacci retracements and extensions

Fibonacci numbers have a basis in ancient mathematics and applying that to trading is what gets you those Fibonacci retracement and extension levels like 62.8%, 50% and more.

Elliott Wave Theory

The Elliott Wave Theory is basically a type of technical analysis that has to do with observing recurring fractal wave patterns that are identified within stock price movements  or consumer behavior

Harmonic patterns

Harmonic trading blends math and patterns together into this method that can be precise and is  based on the premise that patterns tend to repeat themselves.

Intermarket analysis

As the name implies it has to do with analyzing markets by evaluating the correlations between various asset classes.

Combining Technical Analysis with Other Methods

Technical analysis can be combined with other methods too it’s not as if it can only operate efficiently on its own.

Integrating fundamental analysis

You can even integrate fundamental analysis with it which has to do with analyzing the factors influencing the price rather than the price itself.

Sentiment analysis and technical indicators

Then there’s sentiment analysis too which has to do with gauging the overall mood of investors rather than anything else.

If you feel it to be a viable tool then feel free to use it too and there should be some technical indicators that factor sentiment in for you to use.

Using multiple timeframes

Or you can try experimenting with several different time frames to have a more comprehensive understanding of the asset’s market.

Risk Management in Technical Analysis

There’s some risk management that you’d want to factor in too within your technical analysis.

Setting stop-loss and take-profit levels

Entering or exiting to stop your losses and retain profits is one way of managing your risks.

Position sizing based on technical levels

Another way is to adjust your position size to reflect your budget, entry price and so on.

Managing risk in different market conditions

The market will not always be in the same condition and so naturally learning to manage risks in different conditions is vital too.

Limitations and Criticisms of Technical Analysis

But as with anything there will be some limitations you’ll have to consider.

Common misconceptions

That it cant be used for long term trading to that it has low success rates and only individual traders use it are just some of the misconceptions hindering the use of this.

Potential drawbacks and pitfalls

The main drawback has to do with the fact that history doesn’t always tend to repeat itself and that things can go in unexpected turns is always a possibility.

Addressing skepticism in the financial community

Finance is plagued with every manner of volatility that you could imagine so it’s only natural for there to be some skepticism involving some technical analytics.

The Future of Technical Analysis

Let’s see what the future could hold for this.

Artificial intelligence and machine learning in technical analysis

Recent advancements in AI and machine learning will no doubt play some kind of factor.

Evolving techniques and indicators

The way people use techniques or indicators can change and no doubt that will be the case for technical analysis too.

The role of technical analysis in algorithmic trading

Algorithmic trading is quite buzz lately within forex and the role that technical analysis could play in it is apparent.

Conclusion

The enduring relevance of technical analysis

Technical analysis will always be relevant no matter what time or age we live in it’s just that it will likely take different shapes or forms.

Balancing technical analysis with other trading approaches

 But it shouldn’t be the end all be all of trading for you and that you should consider implementing some other approaches in your trading as well.