Technical analysis involves using indicators that follow price movements and help traders to anticipate where the price could be going in the future. Its basic assumptions are:
- • All of the factors that affect a market are reflected in it's price.
- • Prices have a tendency to move in trend.
- • History has a tendency to repeat itself. Human behaviour doesn't change and is reflected in the capital markets in the form price patterns that can be identified on charts.
The indicators that are used:
- Trend lines
- Moving averages
- Chart Patterns
A trend is just any marketable assets price movements in a consistent direction and can be delineated on charts using a straight line known as the trend line. Prices on market charts can rise or fall with a definite tendency to form trends. These help investors anticipate where the prices are going. Trend lines are drawn using the two lowest valleys along the graph for upward trends, and the two highest peaks for downward trends. Using both methods for any trend forms a price channel that contains the price movements. Their direction can be up, down or sideways. Profits can be taken at times by entering into a trade when prices are on or near one of the channel's lines.
Moving averages (MA) are useful tools to be used with trend lines and other indicators. These smooth out the average price and volume movements on the charts emphasizing trends, and they can also help to determine support and resistance areas on the chart. Trend reversals can occur when the chart prices crossover a MA. The MAs will begin crossing over each other at different points during a trend reversal when more than one MA is used. A single crossover can be a signal for a major price movement or it can be meaningless (noise). Additional crossovers of other MAs help to confirm this.
Oscillators measures the rate-of-change in a price of a currency pair and are used for indicating overbought and oversold conditions. Oscillators are particularly useful for trading in range-bound market conditions when there is no trend. A typical oscillator like the three day Relative Strength Indicator consists of a center line and upper and lower margins that denote the overbought or oversold areas. This indicator uses an algorithm that utilizes up days and down days to calculate values that form a line that oscillates between the upper margin, usually set at 80 to 100, and the lower margin, usually set between 0 and 20. The currency pair is considered overbought when it enters the upper margin and oversold when it enters the lower margin. An overbought condition is considered a good signal to be selling and the opposite is considered for an oversold condition.
Recognizable chart patterns will occasionally form from price movements that can indicate trend continuations or reversals. Some of these are triangles (continuation), flags (continuation), pennants (continuation), head and shoulders (reversal), and double tops or bottoms (reversal).
Candlestick charts also show chart patterns but they have another distinct set of patterns that are characteristic of the way price movements within a time frame are rendered on them. A single candlestick shows the opening price, the high and low for the timeframe, and the closing price. One of their shortcomings is that they don't show the exact price movements within a timeframe. They are interpreted as indicating the tug of war between the bears vs. bulls. Some of these are doji (usually indecision), piercing and cloud cover formations (reversal), harami formations (continuation), upside tasuki gap (continuation).
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