Technical Analysis, brief introduction

What is it?

It’s an analysis methodology for predicting the direction of the asset prices. It’s based on the study of the past market data focusing only prices and volume. In addition, there are several technicals indicators that were created by mathematicians and famous investors to avoid the subjectivity of reading charts.

What are the principles behind it?

There are three principles:

• Market action discounts everything
• Price move in trends
• History tends to repeat itself

The first one says that everything is discounted by the market, this is why its followers focus only on prices and volumes. It’s supposed that even a negative external factor will be priced because as soon as someone notices the sellers will come to the market.

Price move in trends, if the prices of the asset are rising it's called bullish trend. If the prices are falling is considered as a bearish trend. This depends on the time frame you check because maybe it's a bearish trend in the 1Hour charts while it's bullish on the daily chart.

The third principle is related to some patterns or price formations. It’s believed that if you see these patterns and according to the past you can guess where the prices will go.

The most famous patterns

Double top, it’s based on two highs in which the price couldn´t go higher. It’s supposed that if the price goes down and breaks the low between the two highs, the price can go down the same distance between one of the hights and the low.

     Source: TradingView, Failed double top in Gold Futures, daily

This example shows a failed double top. In this specific case was due to the growing geopolitical uncertainty that drove the gold prices higher.

Doble bottom, it´s similar to the double top but indicates the initiation of a bullish trend. 

    Source: TradingView, Eurodollar spread Mar19-Mar20, daily

This example is good and shows that after breaking the resistance the Eurodollar spread traded higher. 

Head and shoulders. It's a reversal pattern which can be formed by three peaks  (if the previous trend was bullish) or three troughs (in case of a bearish trend). The range is bigger in the formation in the middle. It shows weakness and can show the final of the trend.

     Source: TradingView, WTI future, daily

This is not the best example, but you can see the formation and the reaction after it broke the neck of this pattern.

Triangles, it´s one of the best figures to trade because usually there is a big move after the triangle is broken.

     Source: TradingView, WTI future, daily

There are more patterns such as flags, channels, diamonds that I’m not going to review in this post.

Technical indicators to follow

The most famous indicators are all classes of the moving average (simple, weighted, exponential) and the crosses between this averages and the price of the asset. The MACD, that basically is a cross between two moving averages with different time frames. The RSI indicates how strong is the movement. The Bollinger Bands were created in the 80s and they create a channel around the price that is adjusted by the volatility. Fibonacci Retracements are quite popular in the trading community because it´s believed that the prices rebound in certain levels.

My opinion

I like it as a quick way to see what’s going on in the different markets. I wouldn’t use in day trading without the support of the market profile. In addition, it’s difficult to use in day trading because unexpected news can affect the asset you are trading. I consider the Technical Analysis as an interesting tool for the medium to long-term (always supported with some fundamentals and risk management)

Conclusion

Technical Analysis is a great way to approach the markets and follow the movements. If you like, there are great books about this topic. In my opinion is not enough for trading, and I would recommend complementing this analysis with another one (depending about the asset you can use fundamental analysis, study the financial ratios, the sector, the economy…)  This was only a brief introduction to Technical Analysis. I will review the technical indicators in the future showing how profitable are in a backtest. I hope you like it. Thanks.

Have a good trading!

Disclaimer

I wrote this article myself, and it expresses my own opinions that shouldn't be used as a trading advice. Trading carries considerable risk due to the high leverage involved

#trading #technicalanalysis  #charting #indicators #introduction