Get an introduction to technical indicators and how to use them.
What is Technical Analysis?
Technical analysis attempts to forecast future price movements by examining past supply and demand changes as that are reflected in changes in prices over time. Most traders use technical analysis to get a "big picture" on an investment's price history. Even fundamental traders will glance at a chart to see if they're buying at a fair price, selling at a cyclical top or entering a choppy, sideways market.
Technical Analysts Make a Few Key Assumptions
All information about market fundamentals are reflected in price data. Moods, differing opinions, and other market fundamentals need not be studied. They are all reflected in the price at a given moment. The price changes as new information becomes available.
History repeats itself in regular, fairly predictable patterns. These patterns, generated by price movements, are called signals. A technical analyst's goal is to uncover a current market's signals by examining past market signals.
Prices move in trends. Technical analysts believe price fluctuations are not random and unpredictable. Once an up, down or sideways trend has been established, it usually will continue for a period.
Find Potential Trade Entry and Exit Points
Traders rely on price charts, volume charts and other mathematical representations of market data (called studies) to try and predict the ideal entry and exit points for a trade. Some studies help identify a trend, while others help determine the strength and sustainability of that trend over time.
Technical analysis can add discipline and minimize emotion in your trading plan. It can be hard to screen out fundamental impressions and stick with your entry and exit points as planned. While no system is perfect, technical analysis helps you see your trading plan through more objectively and dispassionately.
Price Chart Types
The most common type of chart showing price action. Each bar represents a period of time - a "period" as short as 1 minute or as long as several years. Over time, bar charts show distinct price patterns.
Instead of a simple bar, each candlestick shows the high, low, opening and closing price for that period of time it represents. Candlestick patterns provide greater visual detail as they develop.
Point & figure charts
Point & figure patterns resemble bar chart patterns, except Xs and Os are used to mark changes in price direction. Point & figure charts make no use of time scale to associate a certain day with a certain price action.
Technical Indicator Types
Trend indicators smooth price data out, so that a persistent up, down or sideways trend can be easily seen. (Examples: moving averages, trend lines)
Strength indicators describe the intensity of market opinion on a certain price by examining the market positions taken by various market participants. Volume or open interest are the basic ingredients of strength indicators.
"Volatility" refers to the magnitude of day-to-day price fluctuations, whatever their directional trend. Changes in volatility tend to anticipate changes in prices. (Example: Bollinger Bands)
Cycle indicators indicate repeating market patterns from recurrent events such as seasons or elections. Cycle indicators determine the timing of a particular market pattern. (Example: Elliott Wave)
Support and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trend Lines)
Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest when a trend starts and lowest when the trend changes. New information creates uncertainty, which will slow a trend and may reverse it.
When price and momentum diverge, it suggests weakness. If price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price direction. (Example: Stochastic, MACD, RSI)