What is a Technical Analysis?

In the world of finance and trading, it is important to keep an eye on market trends and make wise decisions. This is why you need to know technical analysis. 

If you’ve ever wondered how traders predict market movements and make profitable trades, this comprehensive guide will explain everything you need to know about technical analysis.

Understanding Technical Analysis

Technical analysis is indeed one of the methods to analyze and forecast future price movement by using historical price data and market statistics. 

Fundamental analysis is the quantification process related to a company and dependent on its financial statements or the market, while technical analysis is all linked with and based solely on studying past-market behavior in an attempt to predict future price trends.

The Basics of Technical Analysis

Technical analysis revolves around reviewing historical price charts, volume data (how active a security trades); and other statistical indicators to recognize patterns that can help emerge future trends. 

Traders can use these components to determine what can happen next in the price movement and based on those component traders would be able to make more improved trading decisions.

Key Concepts in Technical Analysis

Price Trends

Trends in prices are the basis of technical analysis. A trend is generally used to describe the overall direction that an asset's price is moving. 

There are three types of trends: Bullish uptrend, Bearish downtrend, and neutral sideways trend. Identifying these trends will allow traders to implement strategies aligned with the direction of the market.

Support and Resistance Levels

Support and resistance are key parts of technical analysis. Support is a price level where a falling trend can be expected to pause, at least temporarily, due to a concentration of buying interest. 

Resistance is a price level where a rally may be expected to stop due to an influx of supply coming back onto the market. A bounce from the most recent level can provide traders with a clue to time when the best entry or exit point may emerge.

Common Tools and Indicators in Technical Analysis

Moving Averages

The role of Moving averages ranges from smoothing out the price data to generating a single flowing line, which helps traders in identifying trading signals to spot a trend. 

Simple moving average (SMA) and Exponential moving average (EMA) are the two most widely used types. These indicators help traders ascertain the position of the trend and support/reversal level

Relative Strength Index (RSI)

RSI (Relative Strength Index) is a momentum oscillator that measures the speed and change of price movements. With values that range between 0 and 100, they are used to help identify overbought and oversold market conditions. 

The RSI above 70 is considered to be an overbought condition and RSI below 30 considers to be the oversold condition.

Bollinger Bands

Bollinger Bands are formed from a simple moving average and two standard deviations around the average. That is to identify volatility and potential breakouts in prices for traders through these bands. 

A move that starts at one band often reaches the other - In other words: A close near an outer band is higher volatility and is indicative that a reversal may be around the corner.

Chart Patterns in Technical Analysis

They represent a visual representation of the psychology in the market and are critical to any technical analysis. There are some well-known chart types:

Head and Shoulders

As the name implies, the Head and Shoulders is a reversal pattern indicating that a trend change will take place. 

Forex Head and Shoulders Pattern: It comprises of three peaks; a higher peak (head), flanked by two lower peaks (shoulders). This setup is a sign the market will change direction, from bullish to bearish or otherwise.

Double Top and Double Bottom

The double top is a bearish reversal pattern that occurs after an asset moves to a new high and then fades lower, only to set another new high before retreating. 

A double bottom is a type of technical analysis reversal pattern that has two low price points. It occurs after a long downtrend and signals that the bearish momentum is increasingly weak. These patterns indicate that the market is about to reverse.

Using Technical Analysis for Trading Strategies

Technical analysis is not just about understanding charts and indicators. Some of the popular strategies traders use are:

Trend Following

A trend following strategy is where a trader will look to take advantage of a trend that already exists. Traders enter trades in the direction of the trend with use of tools like moving averages and tend lines, while they exit when the trend is hinting at reversal.

Swing Trading

Swing Trading - Similar to day trading, except traders hold on to most of their trades for longer and do not mind the overnight exposure. 

Traders use these technical indicators to locate the developed trend and pinpoint possible entry or exit points in that overall trend. Therefore, they can trade in the direction of a trend, allowing them to profit from upswings and downswings.

Scalping

Scalping is a short-term trading style that aims to profit from price changes; hence, the word. Those who employ this strategy depend on either technical indicators or high-frequency trading to rapidly enter and exit positions.

The Importance of Volume in Technical Analysis

Volume is one of the most important concepts in technical analysis and indicates how strong or weak a price move really is. 

A high trading volume indicates strong interest and participation in an asset, while a low volume suggests that there is little interest and possibly on the edge of the market. Volume tells traders about the health of a trend and if a potential reversal could be near.

Limitations of Technical Analysis

Despite being a powerful tool, technical analysis leaps into realm of logical fallacy. This is historical data and will not always be correct about future price movements. 

As you know technical analysis does not know external factors like economic events and news that can change the market completely. Traders must take this together with their technical analysis and keep an ear open for market news.

Combining Technical and Fundamental Analysis

To ensure success and to make informed decisions, most of the time you will see that successful traders use a combination of both technical analysis along with fundamental analysis. 

Technical analysis helps with price trend and market psychology, while fundamental analysis deals with an asset their intrinsic value. By combining both methods, traders can create better trading systems.

Popular Technical Analysis Software and Tools

Traders often resort to special software and technical analysis tools in order to better understand the market trends. Some popular options include:

MetaTrader 4/5

MetaTrader - One of the most popular trading platforms with powerful charting and technical analysis tools plus automated trading features. This is perfect for traders, newbies or pros too.

TradingView

TradingView is an internet-based tool with extensive charting and technical analysis capabilities. The platform features hundreds of indicators, drawing tools and social aspects that allow traders to share ideas and insights.

Thinkorswim

Thinkorswim is a full-service trading platform for professional traders that offers high-quality charting options, real-time data and analysis tools. It is highly used by day traders and investors.

Developing Your Technical Analysis Skills

Technical analysis is a skill that requires practice and constant learning. Here are some tips to help you develop your skills:

Study Historical Charts

Examining historical price charts gives you patterns and trends that have happened simply before. This helps you identify similar patterns when trading in real time.

Use Demo Accounts

Also, most trading platforms all over the world have a demo account for new investors to practice their charts and systems without losing any good-money. These accounts are for sharpening your craft and experimenting with new techniques.

Stay Informed

The trading world is an ever changing place. Follow the markets, developments in technical analysis and trading strategies. Engaging with trading communities and forums to gain insights and learn from experienced traders.

Conclusion

As you all know that technical analysis is an essential strategy for any trader, who performs trading or wanting understand and do well in his performance. 

When working with price data in the past, you can recognize patterns and apply technical indicators, which enables traders to develop successful trading strategies that increase their chances of success. 

That said, while technical analysis is not enough by itself, using it alongside fundamental analysis and keeping in the loop about developments in markets can help you make better trading decisions. Adopt the art of technical analysis and let it lead you in your trading way.