Trading Tutorial: Technical Analysis & TechnicaI Tools

One of the underlying tenets of technical analysis is that historical price action predicts future price action. The availability of long historical data since the internet launch has provided sufficient amount of data to be used to predict future price activity, therefore increasing the statistical significance of the prediction. Technical analysis has now become the perfect tools for traders today, such as trends, charts and indicators.

There are many ways to utilize the technical indicators. Some rely on chart patterns, others use technical indicators and oscillators, and most use a combination of techniques. In any case, technical analysts’ exclusive use of historical price and volume data. Technical analysts don’t concern themselves with fundamental valuation of its asset– the only thing that matters are past trading data and what information the data might provide about future price movements.

In this page, I am going to share some of the mostly used technical analysis nowadays with example. Hope you can enjoy it.

Support and Resistance

Identifying the Support and resistance levels are a critical part for trading because it can be used to make specific trading decisions and identify when a trend is about to reverse. For example, a trader might identify an upcoming support and resistance level and decide to start buying the stock as it approaches knowing that it will likely rebound higher.

Figure 1 – Price Channel – Source: StockCharts.com

As you can see in Figure 1 , the price channel from the previous section, the bottom trendline represents a key support level while the upper trendline represents a key resistance level. The arrows near the top and bottom trendlines show the levels where the price seldom surpassed until it broke out higher. After the breakout, the upper trendline transitioned from a resistance level to a support level for the new trend.

However, if a price breaks out from a resistance, the resistance level becomes a support level moving forward. A little tricky area is that the break out needs to be a true rather than a false breakout, which generally means that it’s accompanied by significant volume and a price spike.

Moving Averages

Moving averages are a powerful tool for traders analyzing securities. They provide a quick overview at the prevailing trend and trend strength, as well as specific trading signals for reversals or breakouts. The most common timeframes used when creating moving averages are the 200, 100, 50, 20, and 10-day moving averages. The 200-day moving average is a good measure for a year timeframe, while shorter moving averages are used for shorter timeframes.

These moving averages help traders smooth out some of the noise found in day-to-day price movements and give them a clearer picture of the trend. In the next section, we will take a look at some of the other techniques used to confirm price and movement patterns.

Figure 2 – Simple Moving Averages – Source: StockCharts.com

Figure 2 shows a stock chart with both a 50-day and 200-day moving average. The 50-day moving average is more responsive to price changes than the 200-day moving. In general, traders can increase the responsiveness of a moving average by decreasing the period and smooth out movements by increasing the period.

Technical Indicator and Oscillators

Indicators represent a statistical approach to technical analysis as opposed to a subjective approach. By looking at money flow, trends, volatility, and momentum, they provide a secondary measure to actual price movements and help traders confirm the quality of chart patterns or form their own buy or sell signals.

Moving Average Convergence/Divergence

The MACD compares short-term momentum and long-term momentum to signal the current direction of momentum rather than the direction of price. Traders can think of it as the ‘derivative’ of price-based moving averages.

When the MACD is positive, it signals that the short-term moving average is above the long-term moving average and the security’s momentum is upward. The opposite is true when the MACD is negative, which signals that the short-term moving average is below the longer term average and suggests downward momentum.

The most common EMAs used in the calculation are the 26-day and 12-day averages, while the signal line is often created using a 9-day MEA of the average of the MACD values. These values can be adjusted by traders, but it’s worth noting that these values are the most widely followed.
                                                 Figure 3 – MACD Crossovers – Source: StockCharts.com

Figure 3 shows some of the major MACD crossovers that suggest a change in price momentum over time.

Relative Strength Index

The relative strength index (RSI) is another well known momentum indicators that’s widely used in technical analysis. The indicator is commonly used to identify overbought and oversold conditions in a security with a range between 0 (oversold) and 100 (overbought).

A reading above 70 suggests that a security is overbought, while a reading below 30 suggests that a security is oversold. Often times, the indicator is used by traders to determine if the price has been pushed to unreasonably higher or low levels after a snap reaction to news.

Figure 4 – RSI Overbought and Oversold Points – Source: StockCharts.com

The standard RSI calculation uses 14 trading days as a basis, although this figure can be adjusted based on a trader’s individual needs.

Stochastic Oscillator

The stochastic oscillator is one of the most recognized momentum indicators in technical analysis. The indicator works on the premise that prices should be closing near the highs of a trading range during upswings and toward the lower end of a trading range during downswings.

The stochastic oscillator is plotted within a range of zero and 100. Readings above 80 are considered overbought while readings below 20 are considered oversold. The oscillator has two lines, the %K and %D, where the former measures momentum and the latter measures the moving average of the former. The %D line is more important of the two indicators and tends to produce better trading signals.

Figure 5 – Stochastic Overbought Signals – Source: StockCharts.com

The stochastic oscillator generally uses the past 14 trading days in its calculations, but as with any indicator, can be adjusted by traders to meet their needs.