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Best Ways to Learn Technical Analysis
In addition to chart patterns and indicators, technical analysis involves the study of wide-ranging topics, such as behavioral economics and risk management. The goal behind technical analysis is usually to identify trading opportunities and capitalize on them using a disciplined, rules-based approach that maximizes long-term risk-adjusted returns. In this article, we will look at some of the best ways for beginners to learn technical analysis without having to risk money in the market.
Build a Foundation
The first step in learning technical analysis is gaining a fundamental understanding of the core concepts, which is best accomplished by reading books, taking online or offline courses, or reading through educational websites covering these topics. Many of these resources are free, but some educators, workshops, or courses charge a fee.
- Technical analysis is the study of charts and patterns, but can also include aspects of behavioral economics and risk management.
- Novice traders can turn to books and online courses to learn about technical analysis.
- Many online trading courses promise spectacular results and use high-pressure sales tactics, but then fail to deliver the promised results.
- Simulated or “paper” trading can help traders see how technical indicators work in live markets.
While countless trading books have been authored, several on technical analysis have withstood the test of time and are go-to resources for novice traders as they start learning how to trade:
- Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications by John J. Murphy
- Market Wizards, Updated: Interviews with Top Traders by Jack D. Schwager
- Reminiscences of a Stock Operator by Edwin Lefevre
- Way of the Turtle: The Secret Methods that Turned Ordinary People into Legendary Traders by Curtis Faith
- Expert Advisor Programming for MetaTrader 5: Creating Automated Trading Systems in the MQL5 Language by Andrew R. Young
Many courses are also available on and offline, including:
Importantly, many online trading courses promise spectacular results and use high-pressure sales tactics, but do not deliver the promised results. Novice traders might want to avoid courses that boast about unrealistic returns and, instead, seek out educators that teach the core fundamentals of technical analysis.
Many traders develop their own trading systems and techniques over time. After all, companies offering “off the shelf” trading systems that yield consistent profits probably wouldn’t be selling them if they were indeed profitable (they would keep the secrets to themselves).
Finally, many different websites provide a detailed overview of technical analysis concepts for no fee, such as Investopedia’s Technical Analysis Strategies for Beginners, and can provide a good starting point for aspiring traders.
Practice and Develop Your Skills
After learning the ins and outs of technical analysis, the next step is to take the principles from these courses and apply them in practice through backtesting or paper trading.
Traders developing automated trading systems can use backtesting to see how a set of rules would have performed using historical data. For example, a trader might develop a moving average crossover strategy that generates a buy signal when a short-term moving average crosses above a long-term moving average and vice versa. The trader could then backtest the system to see how it would have performed over the past several years.
It’s important to keep in mind that trading systems generating compelling returns using historical data aren’t guaranteed to perform well in live markets. In fact, sufficiently complex trading systems can be “curve fit” to perform perfectly using historical data, but won’t be of much use in the future. The best trading systems employ a simple set of rules that perform profitably and are flexible enough to perform well in both the past and in the future.
Traders that place trades on their own without automated trading systems may want to consider paper trading to fine-tune their skills. However, rather than jotting the trades down on paper, using a demo account, traders can practice placing trades to see how they would have performed over time. It’s important to carefully track the performance of these trades to objectively determine how successful the strategies are over time, and to practice over a long enough time frame.
Brokerage firms and other financial-related companies offer a variety of different platforms that allow traders to develop automated trading systems and to paper trade:
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- Interactive Brokers
- TDAmeritrade’s thinkorswim
The Bottom Line
The best way to learn technical analysis is to gain a solid understanding of the core principles and then apply that knowledge via backtesting or paper trading. Thanks to the technology available today, many brokers and websites offer electronic platforms that offer simulated trading that resemble live markets. While there is no shortcut to success, aspiring traders can build a knowledge base and get a feel for the market over time that can provide an edge when trading.
In general, when professional traders are looking at the market to determine their next trade they can use two approaches. The approaches breakdown loosely into the the two following categories: fundamental analysis and technical analysis.
In fundamental analysis a trader will review how the external economic, financial, political, environmental factors affect the value of a security. However, with technical analysis the trader is not interesting in the component factors that determine the market price of an asset. A technical analyst interprets market sentiment to derive conclusions about price trends. Essentially, by using technical analysis, the trader can understand the supply and demand of the market and use that information to estimate the future price trends of an asset.
Any aspiring successful binary options trader or forex traders needs to learn technical analysis. By applying accurate technical analysis of financial markets you significantly increase your chances to for higher returns on trades with stocks, currencies, commodities, and indexes.
I know technical analysis carries a lot of weight. It is one of the bedrocks for a successful career in trading, but don’t be intimidated. In the following article I will walk you through the learning process. If you are already familiar with technical analysis you can check out additional education material or start implementing more advanced strategies.
Let’s Learn Technical Analysis!
Don’t be fooled by the name – this type of analysis is not only about technical analysis charts and graphs. Within technical analysis of financial markets there are systems that provide a trader with rules and methodology for understanding the market, allowing him or her to act with precision, reducing risk and raising profits.
Like learning any new skill, the beginning is just that – the beginning. There is no limit to the amount you can learn about stock market technical analysis or technical analysis indicators . With each new piece of knowledge, your ability to gauge and act upon market sentiment will get sharper and sharper. If you really want to succeed as a binary options trader, you need to keep learning and improving your technical analysis abilities.
What is technical analysis: the basics.
The first thing you need to understand is the concept of a trend. Life is full of trends: political, fashion, entertainment etc. The trends that most interest us as traders are market trends, and just like fashion trends (when was the last time you put on those parachute pants?) market tends are always changing.
A market trend essentially displays the changing price of an asset (stock, currency pair, commodity, index etc.) over time based on the willingness of buyers or sells to respectively buy or sell an asset at a specific price. Technical analysis charts are a great way to visually reflect the changing price of an asset over time. In fact, it is one of the first technical analysis tools you’ll need to get started. The direction of that change in price – up, down, flat – is what we is used to get a feel for market sentiment i.e. the market trend.
Chart 1: The changing price of the EURUSD currency pair over time.
There are 3 types of trends:
- Uptrend – an uptrend is defined by at least two peak highs followed by two peak lows in ascending order. (That’s the minimum required for an uptrend.)
- Downtrend – a downtrend is defined by at least two peak lows followed by two peak highs in descending order. (That’s the minimum required for a downtrend.)
- Horizontal trend – a horizontal trend is defined as a balance between buyers and sellers in the market.
(You might also come across a sideways trend. However, a sideways trend can usually be interpreted as either an up trend or a downtrend.)
Chart 2a: A classic horizontal trend – In a classic horizontal trend 2 peak highs as well as 2 peak lows are set in the same price range.
Chart 2b: A triangle horizontal trend – In a triangle horizontal trend prices are set between 2 boundaries. As the prices converge (move closer together) the width of the highs and lows reduces creating a triangle shape.
Chart 2c: An up trend triangle – With an uptrend triangle, the upper triangular rib is flat and the other rib is sent as an uptrend.
Chart 2d: A downtrend triangle
With a downtrend triangle, the lower triangular rib is flat and the other rib is set as a downward trend.
Important Trader Terminology
Resistance and Support Lines
The most basic technical analysis indicators are resistance and support lines. They are relevant for stock market technical analysis or more general technical analysis of financial markets. As mentioned previously, the price of a security or asset is set by buyers and sellers. When there are more sellers, the market sentiment will display a downward trend. (This means supply increases while demand decreases.) When more people are trying to buy the asset or security, the market sentiment will display an upward trend. The price is going up because the supply decreases as the demand increases.
oftenly what’s happen is that buyers and sellers are switching power at the same price level more than once?
Support Line – occurs when the buyers take control from sellers – the demand increases so there is an upward trend.
Resistance Line – occurs when the sellers take control from buyers – the demand decreases to there is a downward trend.
To define a line of resistance or support all you need is two instances of a switch in the demand of the underlying asset. The reason for this ever changing switching power between buyers and sellers can vary. (That’s what makes trading so fun and challenging!) The cause can be a psychological price level such as 1.2 for EURUSD, fundamental news such as a change in interest rates, political events, and more!
At the end of the day, it doesn’t matter what the reason is for the shift. What matters is the these moments of ‘switching control’ will increase the chances for a retrieve in the future. If, however, the price trend breaks through the support or resistance line, it increases the chances for a nice trade with great returns for trades who recognize and take advantage of the setup.
Bottom line – pun absolutely intended – a resistance or support line can be used to identify a range between which prices display an uptrend or a downtrend.
Technical Analysis – A Beginner’s Guide
What is Technical Analysis?
Technical analysis is a tool, or method Valuation Methods When valuing a company as a going concern there are three main valuation methods used: DCF analysis, comparable companies, and precedent transactions. These methods of valuation are used in investment banking, equity research, private equity, corporate development, mergers & acquisitions, leveraged buyouts and finance , used to predict the probable future price movement of a security – such as a stock Stock What is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms “stock”, “shares”, and “equity” are used interchangeably. or currency pair – based on market data.
The theory behind the validity of technical analysis is the notion that the collective actions – buying and selling – of all the participants in the market accurately reflect all relevant information pertaining to a traded security, and therefore, continually assign a fair market value to the security Public Securities Public securities, or marketable securities, are investments that are openly or easily traded in a market. The securities are either equity or debt-based. .
Past Price as an Indicator of Future Performance
Technical traders believe that current or past price action in the market is the most reliable indicator of future price action.
Technical analysis is not only used by technical traders. Many fundamental traders use fundamental analysis Analysis of Financial Statements How to perform Analysis of Financial Statements. This guide will teach you to perform financial statement analysis of the income statement, balance sheet, and cash flow statement including margins, ratios, growth, liquiditiy, leverage, rates of return and profitability. to determine whether to buy into a market, but having made that decision, then use technical analysis to pinpoint good, low-risk buy entry price levels.
Charting on Different Time Frames
Technical traders analyze price charts to attempt to predict price movement. The two primary variables for technical analysis are the time frames considered and the particular technical indicators that a trader chooses to utilize.
The technical analysis time frames shown on charts range from one-minute to monthly, or even yearly, time spans. Popular time frames that technical analysts most frequently examine include:
- 5-minute chart
- 15-minute chart
- Hourly chart
- 4-hour chart
- Daily chart
The time frame a trader selects to study is typically determined by that individual trader’s personal trading style. Intra-day traders, traders who open and close trading positions within a single trading day, favor analyzing price movement on shorter time frame charts, such as the 5-minute or 15-minute charts. Long-term traders who hold market positions overnight and for long periods of time are more inclined to analyze markets using hourly, 4-hour, daily, or even weekly charts.
Price movement that occurs within a 15-minute time span may be very significant for an intra-day trader who is looking for an opportunity to realize a profit from price fluctuations occurring during one trading day. However, that same price movement viewed on a daily or weekly chart may not be particularly significant or indicative for long-term trading purposes.
It’s simple to illustrate this by viewing the same price action on different time frame charts. The following daily chart for silver shows price trading within the same range, from roughly $16 to $18.50, that it’s been in for the past several months. A long-term silver investor might be inclined to look to buy silver based on the fact that the price is fairly near the low of that range.
However, the same price action viewed on an hourly chart (below) shows a steady downtrend that has accelerated somewhat just within the past several hours. A silver investor interested only in making an intra-day trade would likely shy away from buying the precious metal based on the hourly chart price action.
Candlestick charting is the most commonly used method of showing price movement on a chart. A candlestick is formed from the price action during a single time period for any time frame. Each candlestick on an hourly chart shows the price action for one hour, while each candlestick on a 4-hour chart shows the price action during each 4-hour time period.
Candlesticks are “drawn” / formed as follows: The highest point of a candlestick shows the highest price a security traded at during that time period, and the lowest point of the candlestick indicates the lowest price during that time. The “body” of a candlestick (the respective red or blue “blocks”, or thicker parts, of each candlestick as shown in the charts above) indicates the opening and closing prices for the time period. If a blue candlestick body is formed, this indicates that the closing price (top of the candlestick body) was higher than the opening price (bottom of the candlestick body); conversely, if a red candlestick body is formed, then the opening price was higher than the closing price.
Candlestick colors are arbitrary choices. Some traders use white and black candlestick bodies (this is the default color format, and therefore the one most commonly used); other traders may choose to use green and red, or blue and yellow. Whatever colors are chosen, they provide an easy way to determine at a glance whether price closed higher or lower at the end of a given time period. Technical analysis using a candlestick charts is often easier than using a standard bar chart, as the analyst receives more visual cues and patterns.
Candlestick Patterns – Dojis
Candlestick patterns, which are formed by either a single candlestick or by a succession of two or three candlesticks, are some of the most widely used technical indicators for identifying potential market reversals or trend change.
Doji candlesticks, for example, indicate indecision in a market that may be a signal for an impending trend change or market reversal. The singular characteristic of a doji candlestick is that the opening and closing prices are the same, so that the candlestick body is a flat line. The longer the upper and/or lower “shadows”, or “tails”, on a doji candlestick – the part of the candlestick that indicates the low-to-high range for the time period – the stronger the indication of market indecision and potential reversal.
There are several variations of doji candlesticks, each with its own distinctive name, as shown in the illustration below.
The typical doji is the long-legged doji, where price extends about equally in each direction, opening and closing in the middle of the price range for the time period. The appearance of the candlestick gives a clear visual indication of indecision in the market. When a doji like this appears after an extended uptrend or downtrend in a market, it is commonly interpreted as signaling a possible market reversal, a trend change to the opposite direction.
The dragonfly doji, when appearing after a prolonged downtrend, signals a possible upcoming reversal to the upside. Examination of the price action indicated by the dragonfly doji explains its logical interpretation. The dragonfly shows sellers pushing price substantially lower (the long lower tail), but at the end of the period, price recovers to close at its highest point. The candlestick essentially indicates a rejection of the extended push to the downside.
The gravestone doji’s name clearly hints that it represents bad news for buyers. The opposite of the dragonfly formation, the gravestone doji indicates a strong rejection of an attempt to push market prices higher, and thereby suggests a potential downside reversal may follow.
The rare, four price doji, where the market opens, closes, and in-between conducts all buying and selling at the exact same price throughout the time period, is the epitome of indecision, a market that shows no inclination to go anywhere in particular.
There are dozens of different candlestick formations, along with several pattern variations. Probably the most complete resource for identifying and utilizing candlestick patterns is Thomas Bulkowski’s pattern site, which thoroughly explains each candlestick pattern and even provides statistics on how often each pattern has historically given a reliable trading signal. It’s certainly helpful to know what a candlestick pattern indicates – but it’s even more helpful to know if that indication has proven to be accurate 80% of the time.
Technical Indicators – Moving Averages
In addition to studying candlestick formations, technical traders can draw from a virtually endless supply of technical indicators to assist them in making trading decisions.
Moving averages are probably the single most widely-used technical indicator. Many trading strategies utilize one or more moving averages. A simple moving average trading strategy might be something like, “Buy as long as price remains above the 50-period exponential moving average (EMA); Sell as long as price remains below the 50 EMA”.
Moving average crossovers are another frequently employed technical indicator. A crossover trading strategy might be to buy when the 10-period moving average crosses above the 50-period moving average.
The higher a moving average number is, the more significant price movement in relation to it is considered. For example, price crossing above or below a 100- or 200-period moving average is usually considered much more significant than price moving above or below a 5-period moving average.
Technical Indicators – Pivots and Fibonacci Numbers
Daily pivot point indicators, which usually also identify several support and resistance levels in addition to the pivot point, are used by many traders to identify price levels for entering or closing out trades. Pivot point levels often mark significant support or resistance levels or the levels where trading is contained within a range. If trading soars (or plummets) through the daily pivot and all the associated support or resistance levels, this is interpreted by many traders as “breakout” trading that will shift market prices substantially higher or lower, in the direction of the breakout.
Daily pivot points and their corresponding support and resistance levels are calculated using the previous trading day’s high, low, opening and closing prices. I’d show you the calculation, but there’s really no need, as pivot point levels are widely published each trading day and there are pivot point indicators you can just load on a chart that do the calculations for you and reveal pivot levels. Most pivot point indicators show the daily pivot point along with three support levels below the pivot point and three price resistance levels above it.
Fibonacci levels are another popular technical analysis tool. Fibonacci was a 12 th -century mathematician who developed a series of ratios that is very popular with technical traders. Fibonacci ratios, or levels, are commonly used to pinpoint trading opportunities and both trade entry and profit targets that arise during sustained trends.
The primary Fibonacci ratios are 0.24, 0.38, 0.62, and 0.76. These are often expressed as percentages – 23%, 38%, etc. Note that Fibonacci ratios complement other Fibonacci ratios: 24% is the opposite, or remainder, of 76%, and 38% is the opposite, or remainder, of 62%.
As with pivot point levels, there are numerous freely available technical indicators that will automatically calculate and load Fibonacci levels onto a chart.
Fibonacci retracements are the most often used Fibonacci indicator. After a security has been in a sustained uptrend or downtrend for some time, there is frequently a corrective retracement in the opposite direction before price resumes the overall long-term trend. Fibonacci retracements are used to identify good, low-risk trade entry points during such a retracement.
For example, assume that the price of stock “A” has climbed steadily from $10 to $40. Then the stock price begins to fall back a bit. Many investors will look for a good entry level to buy shares during such a price retracement.
Fibonacci numbers suggest that likely price retracements will extend a distance equal to 24%, 38%, 62%, or 76% of the uptrend move from $10 to $40. Investors watch these levels for indications that the market is finding support from where price will begin rising again. For example, if you were hoping for a chance to buy the stock after approximately a 38% retracement in price, you might enter an order to buy around the $31 price level. (The move from $10 to $40 = $30; 38% of $30 is $9; $40 – $9 = $31)
Continuing with the above example – So now you’ve bought the stock at $31 and you’re trying to determine a profit target to sell at. For that, you can look to Fibonacci extensions, which indicate how much higher price may extend when the overall uptrend resumes. The Fibonacci extension levels are pegged at prices that represent 126%, 138%, 162%, and 176% of the original uptrend move, calculated from the low of the retracement. So, if a 38% retracement of the original move from $10 to $40 turns out to be the retracement low, then from that price ($31), you find the first Fibonacci extension level and potential “take profit” target by adding 126% of the original $30 move upward. The calculation goes as follows:
Fibonacci extension level of 126% = $31 + ($30 x 1.26) = $68 – giving you a target price of $68.
Once again, you never actually have to do any of these calculations. You just plug a Fibonacci indicator into your charting software and it displays all the various Fibonacci levels.
Pivot and Fibonacci levels are worth tracking even if you don’t personally use them as indicators in your own trading strategy. Because so many traders do base buying and selling moves on pivot and Fibonacci levels, if nothing else there is likely to be significant trading activity around those price points, activity that may help you better determine probable future price moves.
Technical Indicators – Momentum Indicators
Moving averages and most other technical indicators are primarily focused on determining likely market direction, up or down.
There is another class of technical indicators, however, whose main purpose is not so much to determine market direction as to determine market strength. These indicators include such popular tools as the Stochastic Oscillator, the Relative Strength Index (RSI), the Moving Average Convergence-Divergence (MACD) indicator, and the Average Directional Movement Index (ADX).
By measuring the strength of price movement, momentum indicators help investors determine whether current price movement more likely represents relatively insignificant, range-bound trading or an actual, significant trend. Because momentum indicators measure trend strength, they can serve as early warning signals that a trend is coming to an end. For example, if a security has been trading in a strong, sustained uptrend for several months, but then one or more momentum indicators signals the trend steadily losing strength, it may be time to think about taking profits.
The 4-hour chart of USD/SGD below illustrates the value of a momentum indicator. The MACD indicator appears in a separate window below the main chart window. The sharp upturn in the MACD beginning around June 14 th indicates that the corresponding upsurge in price is a strong, trending move rather than just a temporary correction. When price begins to retrace downward somewhat on the 16 th , the MACD shows weaker price action, indicating that the downward movement in price does not have much strength behind it. Soon after that, a strong uptrend resumes. In this instance, the MACD would have helped provide reassurance to a buyer of the market that (A) the turn to the upside was a significant price move and (B) that the uptrend was likely to resume after price dipped slightly on the 16 th .
Because momentum indicators generally only signal strong or weak price movement, but not trend direction, they are often combined with other technical analysis indicators as part of an overall trading strategy.
Technical Analysis – Conclusion
Keep in mind the fact that no technical indicator is perfect. None of them gives signals that are 100% accurate all the time.
The smartest traders are always watching for warning signs that signals from their chosen indicators may be misleading. Technical analysis, done well, can certainly improve your profitability Profitability Ratios Profitability ratios are financial metrics used by analysts and investors to measure and evaluate the ability of a company to generate income (profit) relative to revenue, balance sheet assets, operating costs, and shareholders’ equity during a specific period of time. They show how well a company utilizes its assets to produce profit as a trader. However, what may do more to improve your fortunes in trading is spending more time and effort thinking about how best to handle things if the market turns against you, rather than just fantasizing about how you’re going to spend your millions.
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