The Fundamentals of Technical Analysis Explained
The investment arena warrants careful consideration of all the factors needed to make intelligent financial decisions. There are two forms of analysis to consider, notably technical analysis and fundamental analysis. This behind-the-scenes expose a of technical analysis is designed to familiarize traders with the fundamentals of technical analysis, encompassing an introduction to understanding, interpreting, and utilizing charts, graphs, and trends within the ambit of a complex pricing mechanism.
Market volatility, in tandem with the intrinsic forces shaping the pricing of financial instruments should always explored in further detail. In this vein, technical and fundamental analysis are not mutually exclusive. Technical analysis serves as a powerful tool for anticipating the likely movements of financial instrument prices. These instruments include currency pairs and stocks, although they can be commodities, indices, and cryptocurrency too.
Technical Analysis Nugget: Market Behavior Determines Pricing
The rationale behind technical analysis is rooted in the idea that mass-market behavior serves as a reliable indicator of the pricing mechanism. The buying and selling actions of traders tend to reflect what is deemed ‘fair market value’ for traded securities. Proponents of technical analysis believe that history repeats itself vis-a-vis pricing and that the past is a reliable indicator of future market pricing.
It is worth emphasizing that technical analysis is used by traders and investors across the board, including those who focus on fundamental analysis at the basis of their trading decisions. The objective is clear: find low risk financial instruments at affordable entry price levels by using a combination of technical analysis and fundamental analysis. In this vein, charts are extremely important.
Depending on the timeframe that is selected (5 minutes, 15 minutes, 60 minutes, 4 hours, or Daily Charts), price movements can be analyzed, and forecast. For those traders who prefer to complete all of their trades on the same day a.k.a. intra-day traders, shorter timeframes are needed.
Those traders who prefer to hold their positions on financial instruments overnight will tend to focus on the longer timeframe chart such as 4 hour charts, daily charts, weekly charts, et al. Naturally, the shorter the time frame, the more relevant the chart is to the intraday trader, and the longer the timeframe, the less relevant it is to these intraday traders. Depending on current price trends, and the factors driving prices, a trader may be more or less inclined to buy/sell a financial instrument.
Naturally, the type of charts used by traders make a big difference to the visual aspect of the charting. Candlesticks are commonly used as a charting method, with the top of the candle – the flame representing the peak of the pricing, and the base of the candle representing the bottom of the pricing. The highest point a.k.a. the peak of the security is compared against the lowest point a.k.a. the lowest price of the security in the timeframe.
The body of the candle is reflective of the opening and closing prices during the time period in question. Many times, candlestick charts feature in yellow, blue, red, green, and black. The presence of visual cues with candlestick charts makes them the preferred option for traders.
Making Decisions with Moving Averages & Exponential Moving Averages
Candlestick patterns are available in many different variations, commonly forming long-legged indecision patterns, dragonfly bullish patterns, four price patterns, and gravestone bearish patterns. The closing price of the financial instrument at the end of the day, in addition to the up and down price movements throughout the day characterize each of these variations. A bullish candlestick pattern finishes on a high, while a bearish candlestick pattern finishes the day at its lowest price point.
There are many other elements to contemplate with technical analysis, notably MAs, and EMAs. Moving averages are important technical indicators for several reasons. Traders will often implement buy or sell orders based on the short-term moving average performance over the longer term moving average performance. For example, if the 10-day moving average (MA) crosses above the 50-day MA, it can safely be assumed that prices are rising overall, while a downside movement to that effect would indicate a bearish trend.
MACD (Moving Average Convergence Divergence) and Momentum Indicators
Other notable technical indicators include the use of momentum indicators such as MACD (Moving Average Convergence Divergence), Average Directional Movement Index (ADX), Relative Strength Index (RSI), and Stochastic Oscillators. The MACD is a powerful tool available to technical traders, on several levels. These momentum indicators reflect the strength of current price movements. A downturn in a financial instrument’s price may not be as severe as expected, when viewed from the vantage point of MACD.
Alternatively, the momentum may be strong in which case a definite change in strategy is needed. The calculation of MACD is done by subtracting the 26-period EMA from the 12-period EMA. This results in an MACD line. This is comprised of a signal line which is then juxtaposed on top of the MACD line, indicating whether there are sell signals or buy signals. Whenever the MACD moves above the line, it is a buy signal, whenever the MACD moves below the line, it is a sell signal.
This introductory guide to technical analysis underscores just how powerful a resource this trading methodology is for anticipating price movements. While prices can certainly whipsaw wildly at any time, they are often determined as a result of the cumulative actions of market participants, coupled with speculative sentiment.
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