Chart-Formations.com

What is Technical Analysis?

In its simplest sense, technical analysis encompasses the construction of stock charts or price charts to study the past movement of prices in an attempt to anticipate the most probable future movement of that security's price. In other words, technical analysis uses a security's recent historical price movement, namely its open, close, high and low prices, as well as its volume data to construct a stock chart in an attempt to determine in which direction the security should move, be that up or down, based on its historical price data.

Some forms of technical analysis augment the price chart by constructing technical indicators and oscillators that are based on the security's past price data and overlaid on the chart. These indicators and oscillators are interpreted and used to develop trading systems. Other forms of technical analysis are based on identifying archetypical chart patterns, such as the head and shoulders (H&S) pattern and the double top reversal pattern, that reoccur fairly repeatedly as the chart develops.

Technical Indicators

Indicators are the cornerstones of technical analysis and play an important role in giving and confirming entry and exit signals in stock trading systems. There are quite a number of different types of indicators but they all fall into two categories:

Leading Indicators are indicators that lead price movement. In other words, they indicate the probability of a trend reversal in advance. Most leading indicators measure price momentum over a fixed look-back period. Some of the popular leading indicators include the Commodity Channel Index (CCI), the Relative Strength Index (RSI), the Stochastic Oscillator and the Williams' %R (Wm%R).
Lagging Indicators, which follow the price movement, are usually trend-following indicators, such as the Moving Averages (MAs) and Moving Average Convergence/Divergence (MACD). These indicators turn only after the price action has already turned and therefore lag price action.

Leading indicators are usually considered better than lagging indicators as they indicate a probable change in price action before it occurs. They thus offer an early warning of a change in market direction; however, their predictive nature does not necessarily increase their accuracy or validity.

Indicators also measure different aspects of the market action regardless of whether they are lagging and leading indicators. In addition, depending on how they are calculated, indicators can oscillate above and below a zero line. These are called oscillating indicators. Other types of indicators can be trend indicators, momentum indicators, volatility indicators, market strength indicators and cycle indicators. Different types of indicators can often contradict each other as some are better suited to trending markets while others are better suited to non-trending or ranging markets.

It is important that you understand an indicator, what it measures, how it is calculated, and how it reacts to price changes, before you use it. Once you know how an indicator works, and how it reacts to price changes, you would be better equipped at trading the technicals.

Average Directional Index

ADX Indicator

The Average Directional Index (ADX) is a lagging trend indicator designed by J Welles Wilder and indicates the strength of a trend. In other words, when a stock is moving strongly in an up swing or down swing, or whether it's moving in a trading range. ADX is part of an indicator system called Wilder's DMI, which consists of three lines: the +DI line, the -DI line and ADX line but it can also be used on its own to help determine key turning points in the market.

The ADX indicates the strength of the current trend rather than the direction of the trend. It accomplishes this by oscillating between 0 and 100, with values above 25 generally indicating a strong, sustainable trend and values below 20 indicating a weak trend or a flat trading range ...

Bollinger Bands

Bollinger Bands

Bollinger Bands is a volatility indicator that was developed by John Bollinger and is one of the most useful bands in technical analysis. Bollinger Bands can be used to confirm trading signals, and can also indicate overbought and oversold levels relative to a moving average (MA) of a security's price. Bollinger Bands consist of a simple moving average (SMA) and two standard deviations above and below the SMA.

During periods of volatility i.e., during increased price fluctuation, the upper and lower bands open up and widen, and as the price fluctuations reduces, the upper and lower bands begin to contract. A trade signal is generated when the price action breaks out of constricted Bollinger Bands, though, the initial break out is often a false signal ...

Wealth Warning

Trading equities, options, derivatives, currencies and cryptocurrencies, commodities or any other financial security can offer significant returns BUT it can also result in significant losses if the market moves against your position. It requires a strong commitment to skill development, knowledge acquisition, and emotional control. It should be treated as a business with a clear business plan, proper risk analysis, and a defined set of attainable goals. The risk associated with trading the vagaries of the stock markets is probably the most important consideration as it has a profound effect on a trader's emotional control. You should not trade the stock markets with money you cannot afford to lose as there is considerable exposure to risk in any stock market transaction.

Furthermore, the past success of any trading method, strategy, or system is only indicative of future success. Under no circumstances should past success be misconstrued as a guarantee of future success!

Unless otherwise specified, the trading systems and strategies discussed on this website are intended for educational purposes only and are not meant to recommend or promote any trading system or strategy. You are expected to do your own research and testing to determine the validity of a trading method, system, or strategy on the market and instrument you wish to trade.