Technical analysis is the process of studying the evolution of securities, in a quest to determine the probable future rates.
The specialists in technical analysIs start from the principle that the forces of demand and offer are reflected in the prices and volumes of traded securities.
The technical analysis does not offer certitude to what concerns futures, but it can help by predicting possible trend changes.
The information that lay at the basis of technical analysis are represented in a real-time graph, which is interpreted with the purpose of determining when to buy and when to sell securities.
At the basis of technical analysis
lay 3 large principles
Price reflects reality
This principle refers to the fact that all fundamental aspects of securities influence their demand and offer and thus they are included in the price.
Price moves depending on trends
The price of securities shall keep for a certain period its increase of decrease trend.
It is highly unlikely that the investors’ trust moves quickly from trust to mistrust.
Thus, if the price of securities starts to increase, this trend shall be kept for a period of time.
The identification on time of a trend is a very important key for a successful investment.
History repeats itself
The technical analysis of securities reveals immediately the repetitive character of the evolution of its price. We can make an analogy with the cycles of economy.
We shall always have a succession of economic growth and negative ones as well (this is the correct term. It is used “negative economic growth” and not “economic decline”). After many years of technical analysis, the ones who dedicated to study this area have identified some patterns for the prices on the financial market.
The most known ones are implemented in our trading platform and can be easily used.
Price evolution charts
Line and bar charts are the most popular type of charts used, with line charts providing a quick overlook and bar charts – optimum amount of information.
There are different types of charts used in a technical analysis which represent price movements over a given period. Which type of chart to use is a matter of preference by the investor. The most popular are line charts – most often used in the media to represent average price movements.
Next are bar charts and Japanese candles (also known as candlestick charts) – both preferred by investors and traders around the world due to their versatility and the amount of information they can present.
Line charts are the preferred charts used by the media, because of their simplicity.
They display the price (usually average or closing price) of assets (e.g. Commodities or currencies) during a predefined period, e.g. 3 months.
They are helpful for a quick overlook of the medium/long-term trend of an asset.
Bar charts, or sometimes called OHLC, are graphical representations of price levels during a certain time.
They are portrayed by one vertical bar and two horizontal notches on each side of the bar, where the vertical bar represents a price movement in a time unit (e.g. 1, 5, 10 minutes).
When the time unit starts, the “Open” level/price is established and a horizontal notch is displayed on the left side of the vertical bar. The “Closing” level/price is set up the same way (but on the right hand side of the bar) and can be higher or lower than the “Open” price.
During the mentioned period both “High” and “Low” prices are displayed and they account for the length of the vertical bar, where the “Low” is the lowest part of the bar (lowest price level in that time unit) and the “High” is the highest level of the bar (Highest price level in that time unit).
Candlestick charts are popular amongst traders, as they deliver a quick insight into the situation on a market – maximum amount of information in a clear way.
Candlestick charts began their history in Japan, and are probably one of the oldest types of charts, but at the same time one of the most popular. They are somewhat similar to bar charts, however colours differentiate a price increase from a price decrease.
As with a bar chart, candles have one major vertical bar, representing a time unit (e.g. 1, 5, 10 minutes), but instead of having notches on the right and left hand sides, there is a body for which the inside colour depends on a price change. Its increase usually is represented by the colour white or blue, when its decrease is represented by the colours black or red.
Candlestick shadows or wicks represent the lower and maximum price level for a specified time unit, and are thinner than the body. Therefore, candles stress out how a close price relates to an open price.
Trends can be analyzed from the point of view of period they refer to.
We can analyze:
It is very important when analyzing a trend, to take into consideration a relevant period of time for the investments that we are used to do or we set to do.
If you are accustomed with closing positions in the same day after you open them, it is unlikely to study a security trend for a period of 6 months.
It is very possible for the same security to be different on the short, medium and long term.
Trend line is probably the most basic technical indicator. It is a line which shows for a certain time if the trend is up or down-moving.
For an uptrend, the line should unite opening lows with closing lows.
For a downtrend, the trend line shall unite opening highs with closing highs.
The trend channel is represented by a trend line and one line parallel with the trend one in the trend’s direction.
For an uptrend, the parallel line shall be above the trend line.
For a downtrend, the parallel line shall be below the trend line.
Support and resistance
Support and resistance are price levels below or above which a security tends to stay.
A support level represents the level under which the security shall not drop.
Once reached the support level, the security price tends to drop.
After being reached and exceeded many times, the support levels tend to become resistance levels and the other way round.
The Gann analysis is based on Natural Law, geometrical proportions, and the Gann’s law of vibration, where every asset has its own vibration according to its individual energy
William Delbert Gann, was the creator of the very popular Gann analysis, which includes such tools as the Gann Fan, Gann Trend and Gann Grid. Gann used Natural Law (the usage of reason to analyse human nature and its moral acts) and geometric proportions based on the circle, square and triangle, to forecast prices and to provide a base for his theories. His analyses were based only on the relationship between time and price.
Another theory which the general Gann analysis is based on is the Law of Vibration. The principles of Gann’s Law of Vibration, applied to the capital markets, were first presented to the public in his interview in 1909 to the “Ticker and investment digest”, and may be summarised as follows:
Each stock has its own distinctive path and range of activities based on trade volume, direction and others. All of them move according to their individual patterns or as defined by Gann “Vibrations”. Gann also compared the stocks to atoms by stating that the first are also a kind of centre of energy which may also be defined mathematically. Another interesting statement from Gann is the opinion that stocks possess powers just as magnets do – they can attract and repel – meaning that sometimes they may be leaders in a market for a moment, and in the next, just stagnate.
Together with the above theories, Gann concepts were mostly based on mathematics, and its numbers retrieved from ancient history, like egyptology or even the bible. Some numbers had special meaning in his concepts of price forecasting, the most significant being 16, 25, 36, 49, 64, 121 and 144. According to Gann, these numbers together with geometry and natural law have provided the proposed tools with a very significant forecasting ability.
The Fibonacci analysis is based on the “golden ratio” – properties of an infinite number discovered by Fibonacci.
The Fibonacci analysis techniques are based on the characteristics of a number discovered by Leonardo Fibonacci in the 13th century.
Fibonacci analysed a sequence of numbers, where starting figures are 0 and 1, and each number in the sequence is calculated by adding together the two previous numbers. He discovered that this sequence is characterised by an interesting feature.
As the numbers in the sequence are rising, the proportion between the consecutive numbers is getting closer to the infinite number 1.6182[…].
It was discovered that the number 1.6182[…]called “phi” (Φor φ) is a very important number in different areas of science like biology, architecture and others. It is also called golden number or golden ratio due to its specifications.
The golden number is also used in financial markets for forecasting and decision making methods. Another key number is 0.382, which results from the division of one number by the following number of the Fibonacci sequence, or by subtracting from 1 the golden number.
Some of the tools based on the theories behind the Fibonacci numbers are: Fibonacci Fans, Arcs, Time zones, retracement, channel and expansion, Fibonacci retracement being the most popular.
Oscillators are very useful instruments showing the dynamics of price action.
Oscillators are popular amongst traders following technical analysis, as they reflect how fast prices change, as well as the direction in which they are heading. Tools such as price formations are aimed at analysis of trend and its possible reversals, and oscillators try to explain the price dynamics by referring to “overbought” and “oversold” market conditions.
Typically, oscillators reflect the market price changes in relative terms – in respect to some values adopted as boundaries, between which the oscillation takes place, depending on the construction of a given instrument. As the price moves close to the extreme values of such a range, the market is considered to be “overbought” – typically in the case of upper parts of the range, or “oversold” – in the case of lower boundaries.
The most basic method of interpretation of oscillators refers to the oversold/overbought levels – a market that is oversold is expected to regain at least a part of the losses, whereas the market that is overbought is considered to retrace back in a short time.
Signals can be provided also through so called divergencies – situations when the movement of an oscillator does not confirm the movement on the corresponding market. It is assumed that in such a case the market may retrace in the direction indicated by an oscillator.
Some of the oscillators can also be analysed in the same way as a price chart. In this respect trends, trendlines and technical formations can be identified, such as channels or triangles. Results from such an analysis may indicate the possible movement of the given oscillator, and consequently the underlying market.
Oscillators combined together with other tools, such as trend indicators or price formations, may provide a detailed insight into the situation on a given market. It is considered that oscillators perform better when horizontal trends are observed, while providing less reliable signals in the case of fast moving trends.
Trend and its indicators
Trend is the crucial concept in technical analysis of financial markets, as many traders claim – “trend is your friend”.
The concept of trend is fundamental for the appropriate interpretation and use of technical analysis. Basically, the purpose of use of most instruments in the vast array of technical analysis tools, has something in common with the current market trend – sometimes their purpose is to identify its direction or potential moments of its reversal.
Other tools concentrate on measuring the dynamics and strength of the dominating market tendency. However, trend always remains in the centre of technical analysis interest. Trend in respect to financial markets is understood as the direction where the market prices in general are heading. As such, market trends may be horizontal, upward or downward.
As the markets typically do not move in a straight line, (they seem to “jump” instead), the general direction of price waves are the subject of a trend analysis.
Several technical analysis indicators have been created in order to identify the market trend direction, from the most basic heuristic assessment to the most sophisticated statistical tools. The most popular trend indicators are most often based on the average or other statistical instruments, like standard deviation. It may be combined with short or long-term averages to provide buying or selling signals, as for example in the case of Moving Averages. Other more complicated trend indicators use short, medium and long-term averages to provide signals and show trend directions and/or changes.
Elliot waves combined with Fibonacci ratios may be used to forecast potential price targets.
After observing the stock markets, Ralph Elliott (the author of the so-called Elliott theory), concluded that prices tend to move in waves. The Elliott wave theory has been successfully used by traders to predict price movements and/or patterns.
Waves according to Elliott may be divided into two types. The first ones are called “impulse waves”, and are regarded as the main waves moving according to price trend. The second are called “corrective waves” which are considered to be medium/short-term waves moving against a trend.
Elliott got even further by stating that impulse waves are divided into five smaller waves (of which two are corrective waves), while corrective waves are divided into three smaller waves. Elliott waves together with Fibonacci ratios may present very interesting results regarding potential price targets. The most important Fibonacci ratios are 38.2% and 61.8%, beside the 0% and the 100% levels. After defining the beginning of a wave (i), 0% level is defined. The end of wave (i) is defined as 38.2%. Together with an impulse wave, using the Fibonacci ratios, it is possible to potentially define the target level of a wave.
Please obtain independent advice from an independent financial advisor if you have any doubts as to the instruments’ specifications and the market’s mechanisms.