Concepts in Technical Analysis

[Do Or Die 10]

There are many techniques in Technical Analysis which have been called voodoo by academicians. However, if we approach Technical Analysis as study of price behavior, we get sufficient evidence from past data as well as day-to-day market behavior. Here I will mention some concepts which provide foundation to any technical analysis methodology- be it chart patterns, indicators, discretionary wave study (Wolfe or Elliott), MESA, detrending and so on.

 

1. Know Your Markets

Beginners may feel TA is all about charts, and tend to overlook understanding the market segment in which they trade. Well, the fact is that whichever instrument you trade is largely influenced by its related market segment. For example, individual stocks are influenced by their respective industry group, broader stock market, and the economic cycle in which they are in.

 

If you want to trade intraday you need to understand the microstructure of the instruments you are trading. For example, open price auction (and resultant open price behavior) is different among individual stocks.

2. Time Frames and Periods

Everything that you talk about TA will be in reference to a specific time frame. If you say a stock is uptrending it does not makes sense unless you specify ether it is uptrending in intraday or for the past month. Time frame is a ‘snapshot’ of prices at regular time intervals. For example, in the hourly time frame you see the high, low, open and close prices for EACH hour. Time frames of magnitude more than the Daily are referred to as intraday. See the chart, the large price drop towards the end occurs usually more on minute time frames then daily time frames. Similarly time periods in indicators play a very important part in your analysis.

 

Whichever time frame you are trading, it can be very helpful to watch a TF immediately bigger (to see the broad picture) and one time frame immediately smaller (for good trade execution).

 

3. Volatility

Talking about volatility in a general sense will be hardly any use. Refer to Introduction to Understanding Volatility when you get started in Technical Analysis

 

4. Trends

This is the most important part of TA. Prices do not follow a random walk, they exhibit trends. A trend can be up, down and sideways. To mark an uptrend consider the price troughs, to mark a downtrend consider the price peaks, and to mark sideways consider both peaks and troughs. A Moving Average of length 20 is also good to mark visualize immediate trend. Trends exist both in prices and volumes and they tend to correlate. (Refer Trend lines drawn and MA(40) in the chart)

You should never initiate a trade against the current trend.

 

5. Levels

 

Support and Ressistance levels is the next most imprtant concept after trend. These may also be called buying/selling zone, accumulation/distribution level, supply/demand lines and so on. You can mark these levels by referring to past highs and lows. The most recent highs/lows are more important price reference points. The more highs/lows a trend line can connect, the more important that level will be. A support/ressistance line does not neccessarily has to be horizontal; for example in the given chart, the two channel lines act as support and ressistance.

 

When price breaks through previous support, the next time it rises, the same support acts as ressistance. So past support can act as ressistance and vice versa.

 

Here is you first trading strategy trading strategy! Buy in a uptrend when prices retraces to a support level (retracement happens in the immediate lower time frame).

 

6. Momentum or Internal Relative Strength

 

Refer Relative Strength - Internal

The level at which a stock trading relative to its past trading range is important for timing you trade. Even in an uptrend a stock may move down in the shorter time frame or may stagnate at a price level. Oscillators are useful in gauging the momentum.

 

7. Mean Reversion

 

When prices are extended in a particular direction, they tend to revert to their mean. The mean here is just a hypothetical value at which all buyers and sellers would like to see the market. The mean is always moving, and the simplest replacement of mean can be a short-term moving average. Refer to the circles marked in the chart when prices were extended to either direction.

 

So here is your second trading strategy! Buy in a uptrend when prices are extended downwards (oversold) and returning to the mean.

 

Mean reversion in prices tends to correlate with mean reversion in volumes.

 

8. Relative Strength

 

Refer: http://www.traderslaboratory.com/forums/technical-analysis/10189-relative-strength.html

Exactly how stronger an instrument is trading relative to its market segment can be very useful. For intraday time frames it can be used for breakout strategies. For daily/weekly time frames an entire branch of Technical Analysis has spun off called Intermarket Analysis (which may be said to include Sector Rotation or Business Cycle investing).

 

 

 

Posting a comment will only take you 2 minutes, but it will be the strongest motivation for me to share something better.

[ducati-2007 10]

I'm a newbie in TA, thx 4 sharing ur method !

[Do Or Die 10]

I'm a newbie in TA, thx 4 sharing ur method !

 

It's not my method... just the basics of technical analysis Feel free to ask.

[TimRacette 11]

Those are 8 good points. I think to scale back even more we can break it down to price and volume. If we strip out the candlesticks and the studies can we are forced to make sense of the price action.

 

From a holistic standpoint technical analysis is simply a visual representation of human emotion.

[Do Or Die 10]

If we strip out the candlesticks and the studies we are forced to make sense of the price action.

 

So true.

 

I have traded using line charts in intraday. I've seen many successful traders who use only line charts and Excel.