Technical analysis is a system of analysis techniques which can be used to trade stocks, shares, and currencies. Technical analysis is based on the idea that the markets follow trends and that those trends are quite predictable – that asset values will always move within specific bounds.
There are a few core rules to technical analysis, and once you understand those rules you can have a good chance of predicting how the markets will move. There will always be some differences. There will always be some exceptions, but these rules can support a lot of trades. Thanks to the Trading Review team, we were able to label the most important ones below.
Map The Long-Term Trends
Looking at long-term charts that show the asset you want to trade on a monthly or weekly scale, spanning several years, will give you a clear perspective of the market. Once you can see that long-term trend, look at daily and intra-day charts as well. Even if you are planning on trading short term, it’s easy to be deceived by the short-term trends. You need to have a view of the direction of the market longer term.
Support and Resistance
Buy when the market is close to support levels – these are usually a previous low. Sell near resistance, which is a previous peak. Typically, when a resistance level is broken, it becomes a new support level – old highs become new lows. When a support level is broken, it becomes a selling high for the next market rally. Understand that psychological impact, and you will have a better idea of when to take gains and stop losses.
Percentage retracements and market corrections give you an idea of the next market trend. Often, in corrections, retracements of around 50 percent are common. Minimum retracements will be around one-third of whatever the previous trend was. Sometimes, a retracement of two thirds will happen. The Fibonacci analysis retracements are 38% and 62% and are worth watching as well.
Oscillators Identify Markets
Tracking oscillators will show you if a market has been over-sold or over-bought. You can use moving averages to see if a market’s trend is changing, but oscillators offer an indication of whether a market is about to turn in direction soon. The RIS and Stochastics Oscillators are handy indicators. An RSI over 70 suggests a market is overbought, and an RSI below 30 suggests over-selling. With Stochastics, the figures are 80 and 20 respectively. Using a 14 day or 14-week trend for Stochastics, and a 9 to 14 day or week trend for RSI will give you a clear idea of the status of the market. You can use the signals as a filter for narrower charts.
Heed Warning Signs
You can combine moving average data with oscillators to generate something like the Moving Average Convergence Divergence indicator. This will give you buy and sell signals and will give an early warning sign of any potential trend change.
Technical analysis is useful for stable, established markets. Fundamentals can make a market buck the technical trends, but they are still useful to know.