Getting Started In Technical Analysis

You want to learn technical analysis but don't know where to start ? Well, this will hopefully help answer some questions you may have.

What is technical analysis ?

Quite simply, technical analysis is a particular method of studying charts in an effort to establish future price movements. It is used to help guide investors/traders buying and selling decisions. It is not a holy grail system, instead a useful addition to your analysis.

 

AAPL technical analysis

A long term chart of Apple Stock with the blue line representing an uptrend. See how price bounces off the blue line. This is a perfect example of technical analysis of a stock. 

What Markets Can I Use Technical Analysis In ? 

You can apply technical indicators to any market you wish to trade, stocks, bonds, equities, options, currencies, commodities etc. Different indicators work better in different market cycles as we'll outline below.

Any timeframe within your preferred trading or investing instrument can be studied through the use of technical analysis.

 

When does technical analysis work best ? 

I find that different technical indicators work best in different market environments. An example would be in in an up trending market like the AAPL stock in the chart above, buying dips would have been a great example of technical analysis in action.

In choppy sideways markets, mean reversion technical indicators work better on average

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technical analysis of $cat Technical Analysis of Caterpillar

A good example of using technical analysis for mean reversion in sideways markets, i.e. buying support and shorting resistance. 

 

When does technical analysis work poorly ?

  • Extreme price spikes due to geo political news announcements.
  • Illiquid markets i.e. less volume in the instrument you are trading makes it easier to be manipulated and thus rendering your technical analysis studies less effective.
  •  Earnings, Dividend announcements etc. can cause poor technical analysis performance.

 

 

 

HF technical analysis earnings

HF technical analysis with price gap due to earnings. This is a great example of how a news announcement can render your technical analysis study less effective. You'd have been stopped out if you had bought  the support level where the blue line is. 

Recommended reading you might find useful having read this article. 

How to create a trading plan 

A Top Down Approach 

I was going to put this within the 'when technical analysis works best'  but it's so important, I feel it deserves a heading all on it's own. Most of the best traders/investors in the world today adopt a top down approach when using technical analysis.

This means that they start by examining the broad market i.e Nasdaq 100, S&P 500 etc and work their way down to the highest probability times to trade for them within their individual stocks/commodities etc.

A step by step example of a top down technical analysis approach

  1. What is the broad market suggesting based on my technical analysis ? If the price is near support, we know that the higher probability trade is looking for buying opportunities within our stocks.
  2. Then, we go to the stocks we are watching on our list and find the ones that are  trading near support levels.
  3. When we have the overall broad market and the individual stocks within the market lining up, the probabilities are in our favor. Again, this isn't a holy grail but rather a guide to put the odds in our favor.

Here is step 1 example. Examining the broad market on a weekly chart, we can see price traded near its uptrend line in Feb

nasdaq technical analysis

 

Here is an example of step 2 of the top down analysis. At the exact time the overall market was trading into its uptrend support as shown above, Apple Stock was also trading into its uptrend support as shown below.

 

AAPL technical analysis AAPL stock

 

Then this takes us to step 3 which is a higher probability entry price. This can be done by drilling down into a lower timeframe on apple stock e.g hourly, 15 minutes etc to get the best entry for a good risk/reward trade.

This is a great step by step example of the power of technical analysis when applied correctly.

 

What are the best indicators to use ? 

As mentioned above, there are hundreds of different technical indicators out there. Each one works better in different market environments and only when you dig through them can you see what works best for you.

The top 5 most popular indicators are :

  • Moving Averages - This is a technical indicator that helps smooth out price action by filtering out the extreme fluctuations
  • Trend Line Support/Resistance -  My charts outlined above are examples of trend line support/ resistance. Simply plotting lines where price is most likely to react.
  • Volume- Another important indicator for trader/investors arsenal is volume. If you want to buy/sell, it helps guide the trade when you know there is big volume ( i.e. the big institutions are stepping in)
  • Chart Patterns - This can tie in somewhat with trend-lines but in its simplest form, certain price patterns repeat themselves over time and can be exploited to aid trading/investing decisions. Some of the greatest traders today and in the past have applied this approach. 
  • Fibonacci - Developed by Italian Mathematician Leonardo Fibonacci, the formula is a series of numbers and when applied to your charts, can help derive buy/sell signals. More info can be found here.

Is Technical Analysis the Holy Grail? 

No, it is not. It is very important that no one believes that after reading this article, you can just throw up a few indicators and boom, lots of profits. Technical Analysis is a predictive tool. It helps guide us all in the right direction. It is similar to the weather forecast. They are not always right but on average, they can predict when a hurricane is coming.

 

What are some good recommended books where I can learn more ?

There are lots of great books where you can learn lots about technical indicators and their best application to the market.

You might also like to read my favorite top 10 best trading books of all time

Hope you found this to be somewhat useful in getting started with technical analysis. If you have any questions, just comment and I'd be happy to answer.

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