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Technical
analysis assumes that:
• All market fundamentals are depicted in the actual
market data. So the actual market fundamentals and various
factors, such as the differing opinions, hopes, fears,
and moods of market participants, need not be studied.
• History repeats itself and therefore markets move
in fairly predictable, or at least quantifiable, patterns.
These patterns, generated by price movement, are called
signals. The goal in technical analysis is to uncover
the signals given off in a current market by examining
past market signals.
• Prices move in trends. Technicians typically do
not believe that price fluctuations are random and unpredictable.
Prices can move in one of three directions, up, down or
sideways. Once a trend in any of these directions is established,
it usually will continue for some period.
The building blocks of any technical analysis system include
price charts, volume charts, and a host of other mathematical
representations of market patterns and behaviors. Most
often called studies, these mathematical manipulations
of various types of market data are used to determine
the strength and sustainability of a particular trend.
So, rather than simply relying on price charts to forecast
future market values, technicians will also use a variety
of other technical tools before entering a trade.
As in all other aspects of trading, be very disciplined
when using technical analysis. Too often, a trader will
fail to sell or buy into a market even after it has reached
a price that his or her technical studies identified as
an entry or exit point. This is because it is hard to
screen out the fundamental realities that led to the price
movement in the first place.
As an example, let's assume you are long USD vs. euro
and have established your stop/loss 30 pips away from
your entry point. However, if some unforeseen factor is
responsible for pushing the USD through your stop/loss
level you might be inclined to hold this position just
a bit longer in the hopes that it turns back into a winner.
It is very hard to make the decision to cut your losses
and even harder to resist the temptation to book profits
too early on a winning trade. This is called leaving money
on the table. A common mistake is to ride a loser too
long in the hopes it comes back and to cut a winner way
too early. If you use technical analysis to establish
entry and exit levels, be very disciplined in following
through on your original trading plan.
Price charts
Chart patterns
There are a variety of charts that show price action.
The most common are bar charts. Each bar will represent
one period of time and that period can be anything from
one minute to one month to several years. These charts
will show distinct price patterns that develop over time.
Candlestick patterns
Like bar charts patterns, candlestick patterns can be
used to forecast the market. Because of their colored
bodies, candlesticks provide greater visual detail in
their chart patterns than bar charts.
Point & figure patterns
Point and figure patterns are essentially the same patterns
found in bar charts but Xs and Os are used to market changes
in price direction. In addition, point and figure charts
make no use of time scales to indicate the particular
day associated with certain price action.
Technical Indicators
Here are a few of the more common types of indicators
used in technical analysis:
Trend indicators
Trend is a term used to describe the persistence of price
movement in one direction over time. Trends move in three
directions: up, down and sideways. Trend indicators smooth
variable price data to create a composite of market direction.
(Example: Moving Averages, Trend lines)
Strength indicators
Market strength describes the intensity of market opinion
with reference to a price by examining the market positions
taken by various market participants. Volume or open interest
are the basic ingredients of this indicator. Their signals
are coincident or leading the market. (Example: Volume)
Volatility indicators
Volatility is a general term used to describe the magnitude,
or size, of day-to-day price fluctuations independent
of their direction. Generally, changes in volatility tend
to lead changes in prices. (Example: Bollinger Bands)
Cycle indicators
A cycle is a term to indicate repeating patterns of market
movement, specific to recurrent events, such as seasons,
elections, etc. Many markets have a tendency to move in
cyclical patterns. Cycle indicators determine the timing
of a particular market patterns. (Example: Elliott Wave)
Support/resistance indicators
Support and resistance describes the price levels where
markets repeatedly rise or fall and then reverse. This
phenomenon is attributed to basic supply and demand. (Example:
Trend Lines)
Momentum indicators
Momentum is a general term used to describe the speed
at which prices move over a given time period. Momentum
indicators determine the strength or weakness of a trend
as it progresses over time. Momentum is highest at the
beginning of a trend and lowest at trend turning points.
Any divergence of directions in price and momentum is
a warning of weakness; if price extremes occur with weak
momentum, it signals an end of movement in that direction.
If momentum is trending strongly and prices are flat,
it signals a potential change in price direction. (Example:
Stochastic, MACD, RSI)
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