Technical Analysis : Introduction Basic I-IV

Technical Analysis I: Introduction

There are two major approaches to analyzing the currency market, fundamental analysis and technical analysis. The fundamental analysis focuses on the underlying causes of price movements, such as the economic, social, and political forces that drive supply and demand. The technical analysis focuses on the studies of the price movements themselves. Technical analysts use historical data to forecast the direction of future prices.
The premise of technical analysis is that all current market information is already reflected in the price movement. By studying historical price movements, investors can make informed trading decisions. The following articles aim to give a thorough presentation of technical analysis tools and theories.
The primary tools of technical analysis are the charts. The articles first introduced common kinds of charts available on charting software. Charts are also used to identify trending and ranging markets. The articles continued on how to identify support and resistance price, trend lines and price channels. Next, it presented simple trading strategies in trending and ranging markets.
Through careful observation, technical analysts have found recurring patterns on the charts that can give us indication about future price movements. The articles introduced the important patterns, such as the trend reversal and trend continuation patterns. In addition, the Japanese Candle Stick has its own implications in terms of patterns, the articles then introduced how to read the Japanese Candle stick and the inference of its patterns.
Technical indicators are mathematical calculations based on historical prices, they are used extensively in technical analysis to predict changes in trends or price patterns. The final part of the technical analysis is a serious of articles introducing two major types of indicators: trend following indicators and oscillators.

Technical Analysis II: What are Charts?

A chart is the most important tool for understanding the total sum of what is going on in the market. Almost all traders today, particularly those who trade actively, use their favourite types of charts to analyse the market. In the end, a chart is a visualised representation of the price movements, a reflection of the psychology of the market and a visualization of the interaction between buyers and sellers in the market. Because it is a reflection of all the activity that has taken place for a particular traded instrument, a chart also shows how the market values a particular asset based on all the information available. And because a chart has the potential to offer such insight and to accurately reflect the entire perspective of the market, it is an indispensable tool in the arsenal of any trader.
There are three major kinds of charts: bar charts, candlestick charts, and line charts. These charts are described below. Within the articles, we will use primarily candlestick charts, because they are the most commonly used charts amongst active traders.
Three major types of charts:

1. Bar Charts

Bar charts provide traders with four key pieces of information for a given time frame: the opening price during that time frame; the closing price; the high price; and the low price. Bar charts can be applied to all time frames, and hence a single bar can summarize price activity over the past minute or over the past month. Different traders use time frames in various manners, although a good rule of thumb is that the longer the time frame, the more significant it is as it will account for more data -- and hence will be a better reflection of the market's psychology.
Below is an analysis of how a bar chart conveys information.

2. Candlestick Charts

The candlestick charts were invented by the Japanese in the 1700s. Just like a bar chart, a candlestick contains the market's open, closing, low and high price of a specific time frame. The main difference is the candlestick's body part, which represents the range between the opening price and the closing price of that particular time frame. When the body part is filled with red (or black), it means the closing is lower than the opening. When the body part is filled with blue (or white), it means the closing is higher than the opening. While the bar charts put more emphasis on the progression of closing price from the last bar to the next, while the candlestick charts put more emphasis on the relationship between the opening and the closing price within the same time frame. Above and below the candlestick's body are the ‘wicks', while the wick on the top is the highest price and the wick at the bottom is the lowest price of that period. Candlestick charts are more popular than the bar charts and the line charts, because they tend to be more visually appealing.
Below is an analysis of a candlestick chart and its components.

3. Line Charts

Unlike bar and candlestick charts, line charts present much less information; they only show the closing price for a series of periods. As a result, line charts serve best to measure the overall direction of long-term trends, and hence are of limited used for most traders.
Below is an example of a line chart. Note how it clearly and simply shows the direction of the trend.

Technical Analysis III: Support and Resistance

What are support and resistance?
Support levels are prices where buyers have shown or are likely to show strength. Resistance levels are prices where sellers are likely to be strong.

Support

Support levels essentially give the market a 'floor', since they are areas where buyers tend to be strong. If the price falls to a strong support level, traders should expect buyers to step in and drive the price up, or at least keep it from moving any lower.
Because support levels are prices where buyers are supposed to be strong, if the price falls below a support level, this is a signal for the market. It shows that there is more selling pressure (or less buying) pressure than previously thought, and it often leads more traders to exit long positions and take short positions.

Resistance

Resistance levels perform the opposite function of support, which provide a 'ceiling' to the market. If the price rises to a strong resistance level, short sellers should be expected to enter the market and traders in long positions may cover their positions to take profits. This combination of selling pressure will often drive the price lower.
Resistance functions in the same manner as a safety net for short positions and an entry point for traders looking to buy on a breakout.

When a price breaks through a resistant level, it often triggers a large number of stop orders and makes for even greater buying power. Often the stronger the resistant level, greater the number of stops that are triggered and the larger the move above resistance.
Unfortunately, not every breakout is valid. Because they know that many traders place stops to sell just above resistant levels, some large institutional traders attempt to drive the price higher in the short term just to trigger these stops. Without any real force behind the move higher, the price can fall back to resistance. The same dangers of false breakouts apply to support levels as well.

Technical Analysis IV: Identify the Market Trend

Three Phases of Major Trends

A trend represents a general direction of the market. Dow Theory asserts that major trends have three distinct phases: accumulation, public participation and distribution. The accumulation phase represents the first part of the trend in which those who are well-informed buy or sell. In other words, if the well-informed recognize that the recent downtrend is soon coming to an end, they would buy, and vice versa.
The public participation phase involves the masses following the major trend. This occurs as prices begin to accelerate rapidly and there is news supporting the trend.
The final distribution phase occurs as the news highly favors the current trend and speculative volume and public participation increase even further. At this point, the well-informed investors who accumulated when the market was at its peak (trough) begin to sell (buy) before other investors begin to follow suit.

A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed

This is a major theory that essentially mirrors the physical law stating that an object in motion tends to continue in motion until some external force causes it to change direction. Relating that principle to price trends, a strong trend will tend to continue in its current direction unless there is a price reversal indication, as per technical or even fundamental analysis. The later articles will focus on learning to spot reversals in the market and how traders can place orders to take advantage of such reversals.