What is Technical Analysis?
Technical analysis (TA) is an indispensable tool for the day trader. Simply put, TA is about trying to interpret a chart using different technical and mathematical tools. Used correctly, it can give us an indication of which direction, the market may go next. On the other hand, the power of TA is not to be overrated, as all it is capable of is to point to the most probable outcome over the next few minutes, hours, weeks, or months – depending on the time frame we use. It has never been – and will never be – a crystal ball.
Technical Analysis is a completely different way of looking at the financial markets than what we know from Fundamental Analysis and Macroeconomics, which are both covered in another article. These areas are what a private investor usually would consider first, when it comes to stock trading and investing. And this happens to be the main focus of the financial media outlets as well, whereas the interest in TA is typically rather limited.
Former for teknisk analyse: Indikatorer og Price-Action
Indicators are based upon mathematical formulas that are more or less complex. The vast majority of indicators are lagging indicators as they are derived from previous prices and price bars, therefore by definition more concerned about the (recent) past than what is going on right now. It is one of the major criticisms directed at the use of indicators. The proponents, on the other hand, would claim that indicators do work from a statistical point of view – if nothing else because enough traders abide by them, thus making it a case of “self-fulfilling prophecies”.
Moving average: There are two forms, simple and exponential – i.e., SMA and EMA. Gives us an indication of the overall sentiment in the market and the building of trends.
Pivotpoints: As suggested by the name, these are points – or areas rather – at which the price might turn or at least pause in its current move.
Bollinger bands: Are envelopes surrounding a simple moving average at a level of the standard deviation above and below. A lot of the time price will be within the envelope, but when it overshoots on either side the market is thought to be in an “overbought” or “oversold” state.
Fibonacci: Is a method based on a sequence of numbers that has its roots in ancient Mathematics (early Middle Ages to be precise). It is said to be able to describe various phenomena in nature. It also has its use in modern day Chaos Theory (a branch of Mathematics), as a characteristic of fractals. In Technical Analysis Fibonacci numbers, retracements, and extensions are widely used to make predictions of a certain move (“How far will it go?”, “Where should I take profit?”, etc.). However, some claim this to be all nonsense. Yet, if enough believe in the levels calculated by this method, by default it should work to some extent.
Oscillators: Exist in a variety of forms, with a few common ones being RSI, Stochastics and MACD. Generally, they are momentum indicators which means they will provide an indication of the strength of the current move in the market. As suggested by the name, they oscillate – swing – up and down on a pre-defined scale (e.g., 0-100). They are depicted in a separate chart below the main chart.
Volume: a volume indicator gives you a graphic depiction of the activity in the market over time. It is usually shown in a bar chart below the main price chart.
Price Action: Is a school of thought within Technical Analysis, in which emphasis is given on the chart itself. Indicators are only used sparingly. You may find an article dedicated to the description of Price Action in the menu above. However, here is an incomplete list of tools used within Price Action:
- Various lines that you can draw to assist you in your trading. Examples of this, are trend lines, support and resistance lines, ranges, channels, and wedges.
- All sorts of patterns in the market, for instance Gartley patterns and ‘ABCD’. Or classical patterns such as double tops or bottoms, ‘head and shoulders’ and so on.
- Figures and shapes at candlestick level. This of course presupposes the use of a candlestick chart of sorts, as opposed to for example a line chart. Here we are dealing with singular candlestick or the combination of a few. This is where we meet the doji, the hammer, the shooting star, extension bars, the bullish engulfing pattern, and loads more.
If you are interested in learning more about technical analysis, trading and investing, I will have my full online course ready in english during the fall 2022.