Technical analysis is an essential part of trading. It is a method used to predict the future price movement of assets, like a commodity or digital currency, based on market data. Traders use technical analysis when they have chosen the day trading, trend, position, swing, and scalping strategies.
The following steps will help you understand technical analysis and how it is applied to choosing the right assets to trade.
Read charts to spot price trends
Technical analysts look at charts and graphs of asset prices to spot the general direction in which prices are headed (the trend), overlooking individual fluctuations. Technical analysts use four kinds of charts to analyze the trend. They use line charts to plot closing stock prices over time, bar and candlestick charts to show the high and low prices for the trading period (and gaps between trading periods if there are any), and point and figure charts for significant price movements over time.
Understand the concepts of support and resistance
Support refers to the lowest price an asset reaches before more buyers come in and drive the price up. Resistance refers to the highest price an asset reaches before owners sell their shares and cause the price to fall again. These levels are not fixed but fluctuate. On a chart depicting channel lines (successive highs or successive lows), the bottom line is the support line (floor price for the security), while the top line is the resistance line (ceiling price).
Support and resistance levels are used to confirm whether a trend exists and identify when the trend is reversed.
Typically, when securities are trading near a support level, technical analysts avoid buying due to price volatility. However, they can buy into a few points of that level.
Pay attention to the volume of trades
The volume of trades shows the validity of a trend or whether it will reverse itself. If the buying and selling volume increases considerably even as the price rises substantially, the trend is probably true. If the trading volume increases only slightly (or falls) as the price goes up, the trend will likely reverse itself.
Use moving averages to predict the trend and filter out minor price fluctuations
A moving average is a series of calculated price averages measured over successive and equal periods. Moving averages eliminate unrepresentative highs and lows, making it easier to see overall trends. There are several averaging methods used:
– The simple moving average (SMA) is found by adding all the closing prices during a specific period and dividing that sum by the number of prices included.
– The linear weighted average takes each price and multiplies it by its position on the chart before adding the prices and dividing by the number of prices. We would calculate the linear weighted average for a five days period like this: multiply the price of the first day by 1, the second by two, the third by three, and so on, and add them together. After that, we divide the sum by five.
– Exponential moving average (EMA) is similar to the linear moving average, except that it weighs only the recent prices used in calculating the average. That makes it more responsive to the latest market changes than a simple moving average.
Use indicators to understand what the price movements are telling you
Indicators are calculations that support the information gathered from price movements and add another factor to your decision to buy or sell assets.
Indicators may be either leading or lagging: Leading indicators predict price movements, and lagging indicators confirm price movements.
Here are some of the indicators you need to track:
– The main indicators used to understand the trend include the Aroon indicator and the average directional index (ADX).
– The best-known volume indicators are the moving average convergence-divergence (MACD) indicator and the on-balance volume (OBV) indicator.
– To understand how frequently assets are being traded, traders use the relative strength index (RSI) and the stochastic oscillator.