There is always huge amount of money at stake when trading in share market which makes it look like a tensed war field. These tensed situations create unnecessary anxiety levels among traders. Technical analysis calms this adrenaline rush. In simple words, technical analysis forecasts the direction of prices of securities through the study of past market data, primarily price and volume. It is like a quiver in itself that has many sharp and effective arms, better known as technical analysis tools.

Technical analysis is a creative and dynamic process that puts you in the driver's seat, most of the time with high accuracy. By learning technical analysis, a trader gets equipped with logical reasoning power that helps him to not only select profitable bids but also to avoid the less appealing or the wrong ones. Still, if he or she is on the losing side, technical analysis helps to manage that loss with high efficacy.

This section explains everything about technical analysis in a simple question and answer format. The key topics covered include what is technical analysis, what is a price chart, support and resistance levels, key technical analysis indicators, different kinds of technical analysis and the most commonly used chart patterns. Scroll down to become a technical analysis expert.

Request a call back

report

SIGN UP FOR INVESTMENT NEWSLETTER!


Technical Analysis is the practice of anticipating price changes of a financial instrument {like shares} or market as a whole by analyzing prior price changes and looking for patterns and relationships in price history. It is the art of gauging the trends, momentum and the overall sentiment behind the price movement of a stock or any other security helping us to make the investment decision. Lying the foundation of technical analysis are hundreds of indicators that are used, compare, screen and then applied as a part of an underlying investment strategy. However it is interesting to note that no single indicator has ever been found to be completely conclusive.

Charts are the key tool used in technical analysis. For each instrument, the daily and weekly charts are analyzed to identify various types of technical analysis opportunities. Some events are bullish suggesting a rising price, while others are bearish suggesting a falling price.

Martin J. Pring quoted in his book technical analysis:

"The technical (or scientific) approach to investing is essentially a reflection of the idea that prices move in trends which are determined by the changing attitudes of investors toward a variety of economic, monetary, political and psychological forces. The art of technical analysis - for it is an art - is to identify trend changes at an early stage and to maintain an investment posture until the weight of the evidence indicates that the trend has been reversed."

Seekhna Band To Jeetna Band. Going by this adage, to become a successful trader you should never stop learning. The urge to learn new things and new concepts take you to a completely different level not only as a trader but also in your social life. Learning technical analysis is comprehensive yet filled with fun and there obviously is no age bar to explore the world of charts. Read on to learn about some very popular and easy to apply methods, patterns and indicators used in technical analysis along with some basic concepts.


FUNDAMENTAL ANALYSIS TECHNICAL ANALYSIS
Fundamental analysis is a method of forecasting the future price based on strength of business and economic factors. Technical analysis is a method of predicting price movements by studying charts of past market action.
Fundamental Analysis focuses on:
  • Demand & Supply
  • Seasonal cycles
  • Financial health
  • Government policies
  • Long term goals of investors
Technical Analysis focuses on:
  • Price
  • Volume
  • Open interest (futures only)
  • Short to long term goals of investors

A price chart is a sequence of prices plotted over a specific time frame. In statistical terms, charts are referred to as time series plots. On the chart, the y-axis (vertical axis) represents the price scale and the x-axis (horizontal axis) represents the time scale.


Volume is simply the number of shares or contracts that trade over a given period of time, usually a day. To determine the movement of the volume (up or down), volume bars can usually be found at the bottom of any chart. Volume bars illustrate how many shares have traded per period and show trends in the same way that prices do. Volume is an important aspect of technical analysis because it is used to confirm trends and chart patterns. Any price movement up or down with relatively high volume is seen as stronger. Volume is closely monitored by technicians and chartists to form ideas on upcoming trend reversals. If volume is starting to decrease in an uptrend, it is usually a sign that the upward run is about to end.

Support and resistance are two very commonly used terms and most highly discussed attributes of technical analysis. Just like the general rule, in technical analysis also increased supply results in a bearish market and increased demand results in a bullish market.

Support is the price at which demand is thought to be strong enough to prevent the price from declining further. This happens when the prices have reached a point when the security gets cheaper and buyers' interest is created to enter the security and sellers are less inclined to sell the same. Whereas resistance is the price level at which sellers are expected to enter the market in sufficient numbers to take control from buyers which prevents the prices of security from rising further.


Technical indicators are series of data points plotted as a chart pattern derived using mathematical calculations based on historic price and volume of a security to forecast the market trend. They can be categorised based on their common characteristics namely price, volume and oscillators indicators, where price indicators help gauge the overall price movement trends while volume indicators help gauge the overall sentiment of the market.

It is important to note that reading the indicators is more of an art than science because the same indicator may exhibit different behavioural patterns on different securities. Through in-depth study and experience the expertise to read various indicators correctly develops over time.

Charts are graphical displays of price information of securities over time and are the most fundamental aspects of technical analysis. While technical analysis uses a wide variety of charts that show price over time, there are four key chart types that are used by investors and traders - the line chart, the bar chart, the candlestick chart and the point and figure chart. Which chart type the technical analyst would use depends on what kind of information they are seeking and their individual skill levels.

Bar charts are used to illustrate movements in the price of a financial instrument for a time period.

In a bar chart the open, close, high, and low prices of stocks or other financial instruments are embedded in bars which are plotted as a series of prices over a specific time period. It is made up of series of vertical lines that represent each data point. As seen on the chart, the top of the vertical line indicates the day's high price of the security, and the bottom represents the lowest price. The closing price is displayed on the right side of the bar, and the opening price is shown on the left side of the bar.

A price bar shows the opening price of the financial instrument, which is the price at the beginning of the time period, as a left horizontal line, and the closing price, which is the last price for the period, as a right horizontal line. These horizontal lines are also called tick marks.


A chart that displays the opening, high, low, and closing prices of a security for a single day. The wide part or the box of the candlestick is called “the body” or the “real body” and it shows whether the closing price of the security was higher (black/red) or lower (white/green) than the opening price. The long thin lines above and below the body represent the high/low range and are called “shadows”, also referred to as “wicks” and “tails”. You will notice that the body on candlestick charts have hollow and filled candlesticks. Basically hollow candlesticks, where the close is greater than the open, indicate buying pressure whereas filled candlesticks, where the close is less than the open, indicate selling pressure on the security/market under analysis.

Candlesticks shows the impact of investor sentiments on the price of the security and are used by traders to determine when to enter or exit trades.


Using candlesticks as the main weapon: Since candlestick charts provide a broader view of the price trend, we will use them as the base of our further learning.

There are various types of one candlestick patterns, two candlestick patterns and three candlestick patterns used for technical analysis. Below are the most popular patterns:

1. One candlestick patterns

  • Doji: Doji pattern is formed when a security's open and close are virtually equal. The resulting candlestick looks like either a cross, inverted cross, or plus sign. Doji conveys a sense of indecision and thus only any breakout or breakdown can give trade signal.


  • Hammer: Hammer candlesticks form when a security moves significantly lower after the open, but rallies to close well above the intraday low. The resulting candlestick looks like a square lollipop with a long stick or like a hammer. Hammer is a bullish reversal candlestick pattern.


  • Black Or White Marubozu: A candlestick with no shadow extending from the body at either the open, the close or at both. The Japanese name Marubozu means a Bald or Shaved Head. The candlestick can be a reversal as well as of a continuation type.

  • Shooting Star: A single day pattern that can appear in an uptrend. It opens higher, trades much higher, and then closes near its open. It looks just like the Inverted Hammer except that it is bearish.

2. Two candlestick patterns:

  • Engulfing pattern: A reversal pattern that can be bearish or bullish, depending upon whether it appears at the end of an uptrend (bearish engulfing pattern) or a downtrend (bullish engulfing pattern). The first day is characterized by a small body, followed by a day whose body completely engulfs the previous day's body.


  • Harami Pattern: 'harami' is a Japanese word meaning pregnant lady. Harami candlestick pattern thus is a two days pattern that has a small body day completely contained within the range of the previous day's candlestick's body. The pattern can be bullish reversal or bearish reversal, depending on its formation at bottom or top of the present trend.


  • Piercing Pattern: Piercing candlesticks is a bullish reversal pattern. In a downtrend the first day is a long black day. The next day opens at a new low but closes above the midpoint of the body of the first day.

  • Dark Cloud Cover: A bearish reversal pattern where the ongoing uptrend continues with a long white body. The next day opens at a new high but closes below the midpoint of the body of the first day. The pattern is exactly opposite to the piercing pattern.

3. Three candlestick patterns:

  • Abandoned Baby: A three candlesticks rare reversal pattern characterized by a gap followed by a Doji, which is then followed by another gap in the opposite direction. The shadows on the Doji must completely gap below or above the shadows of the first and third day.


  • Rising Three Methods: A bullish continuation pattern in which a long white body is followed by three small body days, each fully contained within the range of the high and low of the first day. The fifth day closes at a new high.


  • Three Black Crows: A bearish reversal pattern consisting of three consecutive long black bodies where each day closes at or near its low and opens within the body of the previous day.

  • Stick Sandwich Pattern: A bullish reversal pattern with two black bodies surrounding a white body. The closing prices of the two black bodies must be equal. A support price is apparent and the opportunity for prices to reverse is quite good.

Moving averages smooth the price data to form a trend following indicator. They do not predict price direction, but rather define the current direction with a lag. Moving averages lag because they are based on past prices. Despite this lag, moving averages help smooth price action and filter out the noise. Simple Moving Average (SMA) is one of the most popular types of moving averages. Simple Moving Average can be used to identify the direction of the trend or define potential support and resistance levels.

SMA: A simple moving average is formed by computing the average price of a security over a specific number of periods. Most moving averages are based on closing prices. For example, a 5-day simple moving average is the five day sum of closing prices divided by five. As its name implies, a moving average is an average that moves. Old data is dropped as new data comes available. This causes the average to move along the time scale.

Crossover: Two moving averages can be used together to generate crossover signals. A bullish crossover occurs when the shorter moving average crosses above the longer moving average. This is also known as a golden cross. A bearish crossover occurs when the shorter moving average crosses below the longer moving average. This is known as a dead cross. These signals work great when a good trend takes hold. However, a moving average crossover system will produce lots of whipsaws in the absence of a strong trend.

RSI is one of the most commonly used technical indicators that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of a security. In simple words RSI interprets the strength of a stock by comparing between the days that the stock closes up and the days it finishes down.

RSI is calculated using the following formula: RSI = 100 - 100/(1 + RS*)
* RS = Average of x days' up closes / Average of x days' down closes (Source)

RSI ranges from 0 to 100. Generally when RSI reaches around 20, it is considered to be an oversold market signalling it is time to buy, whereas when RSI reaches around 80 it is considered overbought and it indicates a sell signal. However, this is not a hard and fast rule and the trader must consider other factors when making a decision.

Developed by Gerald Appel in the late seventies, the Moving Average Convergence-Divergence (MACD) indicator is one of the simplest and most effective momentum indicators available. The MACD turns two trend-following indicators, moving averages, into a momentum oscillator by subtracting the longer moving average from the shorter moving average. The MACD fluctuates above and below the zero line as the moving averages converge, cross and diverge. Traders can look for signal line crossovers, centerline crossovers and divergences to generate signals.

Here is an overview of the most commonly used chart patterns:

Double Top

The double top is a frequent price formation at the end of a bull market. It appears as two consecutive peaks of approximately the same price. The two peaks are separated by a minimum in price, a valley. The price level of this minimum is called the neck line of the formation. The formation is completed and confirmed when the price falls below the neck line, indicating that further price decline is imminent.

Double bottom

A double bottom is the opposite pattern of the double top signaling a declining market. The pattern closely resembles the shape of a 'W' and is formed by two price minima separated by local peak defining the neck line. The formation is completed and confirmed when the price rises above the neck line, indicating that further price rise is imminent. However to confirm this pattern the security needs to break through the support line to signal a reversal in the downward trend and should be done on higher volume.

Head and shoulders (top)

The head and shoulders chart pattern is one of the most popularly used and most reliable pattern in technical analysis. It is a reversal pattern whose formation consists of a left shoulder, a head, and a right shoulder and a line drawn as the neckline.

The left shoulder is formed at the end of an extensive move during which volume is noticeably high. After the peak of the left shoulder is formed, there is a subsequent reaction and prices slide down to a certain extent which generally occurs on low volume. The prices rally up to form the head with normal or heavy volume and subsequent reaction downward is accompanied with lesser volume.

The right shoulder is formed when prices move up again but remain below the central peak called the Head and fall down nearly equal to the first valley between the left shoulder and the head or at least below the peak of the left shoulder. Volume is lesser in the right shoulder formation compared to the left shoulder and the head formation. A neckline is drawn across the bottoms of the left shoulder, the head and the right shoulder. When prices break through this neckline and keep on falling after forming the right shoulder, it is the ultimate confirmation of the completion of the Head and Shoulders Top formation. It is quite possible that prices pull back to touch the neckline before continuing their declining trend.

Ascending Triangle Pattern

An ascending triangle is considered a bullish continuation signal. It is considered a consolidation pattern prior to continuation of the uptrend. An Ascending Continuation Triangle shows two converging trend lines. The lower trend line is rising and the upper trend line is horizontal. This pattern occurs because the lows are moving increasingly higher but the highs are maintaining a constant price level. The pattern will have two highs and two lows, all touching the trend lines. This pattern is confirmed when the price breaks out of the triangle formation to close above the upper trend line. Volume is an important factor to consider. When breakout occurs, there should be a noticeable increase in volume.

Open
An Account
NOW!

Create your account online just with
few easy steps.

START HERE