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Introduction to Technical Analysis

Technical analysis is becoming an increasingly popular method of trading, in part due to advances in charting software packages and trading platforms. However, for novice traders, understanding technical analysis and how it can help predict market trends can be daunting and challenging.

Technical analysis is the study of market price action where traders use historical chart patterns and indicators to predict future trends in the market. It provides a visual representation of how the market has performed in the past and is currently performing, and traders can use this information in the form of price behavior, indicators, and patterns to guide and predict future trends before placing a trade.

Understanding Technical Analysis

Technical analysis involves the interpretation of chart patterns. Traders use historical data (based primarily on price and volume) and use this information to identify trading opportunities based on common patterns in the market. Different indicators are applied on the charts to identify entry and exit points for traders to maximize trading potential with the best risk-reward ratio.

Below is an example of a chart using the MACD and RSI indicators.

While advocates of fundamental analysis believe that economic factors are the main contributors to movements in the markets, technical analysis traders maintain that past trends can assist in predicting future price movements. Although these trading styles can vary, understanding the differences between fundamental and technical analysis – and how to combine them - can be extremely beneficial.

How Technical Analysis can Help Traders

Many traders have found technical analysis to be a useful tool for risk management, which can be a key stumbling block. Once a trader understands the concepts and principles of technical analysis, it can be applied to any market, having it a flexible analytical tool. Where fundamental analysis looks to identify intrinsic value in a market, technical analysis looks to identify trends, which conveniently can be caused by the underlying fundamentals.

The benefits of using technical analysis include the following:

Can be applied to any market using any timeframe

Technical analysis can be used as a standalone method

Allows traders to identify trends in the market

Using Charts in Technical Analysis

Below is an example of a candlestick chart for the EUR/USD currency pair.

Charts are the key to technical analysis. This is because the most important indicator of the market's past and current performance is the price itself; this is the starting point for an in-depth analysis of trading potential. Price behavior can be represented on charts as this is the clearest indication of price action.

Charts help to determine the general trend, whether long or short-term, whether it is an uptrend or a downtrend, or to identify range-bound conditions. The most common types of technical analysis charts are line, bar, and candlestick charts.

When using bar or candlestick charts, each cycle provides the technical analyst with information about the opening price, the cycle high or low, and the closing price. Candlestick analysis is particularly useful because the patterns and relationships within them can help predict the future direction of prices.

Once traders have mastered the basics of charting, they can use indicators to assist in identifying trends.

Technical Analysis Indicators

Indicators are used by technical traders when looking for opportunities in the market. Although many indicators exist, traders often make use of volume and price-based indicators. These assist in determining where the levels of support and resistance are, how often they are maintained or breached as well ascertaining the length of a trend.

A trader can view the price or any other indicator using multiple time frame analyses, ranging from one second to a month, which gives the trader a different perspective of the price action.

The more popular indicators for technical analysis include:

Moving Averages

Relative strength index (RSI)

Moving average convergence divergence (MACD)

The EUR/USD chart below shows how to make use of different indicators.

Moving averages and MACD are often used to identify trends in the market while the RSI is typically used to determine possible entry and exit points. Indicators assist traders in analyzing the market, validating trade setups, and determining entry points.

Chart technical analysis aims to identify patterns and market trends using different forms of technical chart types and other charting features. Interpreting charts can be daunting for novice traders, so it is vital to understand basic technical analysis.

How many types of charts are there？

There are three main types of technical analysis charts: candlestick, bar, and line charts. They are all created using the same price data but display the data in different ways. As a result, they involve different types of technical analysis to help traders make informed decisions across forex, stocks, indices, and commodities markets. While there are several different types of charts, this article covers only the top three because these three are the most widely followed.

The three charts presented below have been selected as they are universal across most trading platforms.

Top 3 types of technical analysis charts for trading

Line Charts

Best for trading: Stocks

Trading experience: Beginner

Technical analysis technique: Holistic market overview which eliminates shifting data

Advantages: Supports trading without the influence of emotions

A line chart typically displays closing prices and nothing else. Each closing price is linked to the previous closing price to make a continuous line that is easy to follow.

This type of chart is often used for television, newspapers, and many web articles because it is easy to digest. It provides less information than candlestick or bar charts but it is better for viewing at a glance for a simplistic market view.

Another advantage of the line chart is that it can assist in managing the emotions of trading by selecting a neutral color, like the blue chart depicted above. This is because the line chart eliminates ‘choppy’ movements in different colors as seen in the bar and candlestick charts.

Expert tip: Due to the line chart illustrating only closed prices, more experienced traders will consider a line chart to map out the daily closing prices or for situations when the analyst wants to inspect the sub-waves without noise.

Bar (HLOC) Charts

Best for trading: Forex, stocks, indices and commodities

Trading experience: Intermediate

Technical analysis technique: Use price data (HLOC) to identify trends, support/resistance, and entry points

Advantages: Provides the trader with more detail which helps to identify key levels and in-depth data

A bar chart displays the high, low, open, and closing (HLOC) prices for each period designated for the bar. The vertical line is created by the high and low prices for the bar. The dash to the left of the bar was the opening price and the dash to the right signals the closing price.

Being able to identify whether a bar closes up (green) or down (red), indicates to the trader the market sentiment (bullish/bearish) for that period.

The similarities between this chart type and a candlestick chart are visible when they are viewed side by side, but a bar chart is better for a cleaner market view. By removing the bolded color from the chart, traders can view market trends with an uncomplicated outlook.

Candlestick Charts

Best for trading: Forex, stocks, indices and commodities

Trading experience: Intermediate

Technical analysis technique: Equivalent to the bar chart technique (dependent on trader preference)

Advantages: Candlesticks are easier on the eye for traders as opposed to bar charts, due to the fuller nature of the candlestick

A candlestick chart displays the high, low, open, and closing (HLOC) prices for each period designated for the candle. The “body” of each candlestick represents the opening and closing prices while the candle “wicks” display the high and low prices for each period.

The color of each candle depends on the applied settings, but most charting packages will use green and red as the default colors. The green candles reflect that the price closed higher than where it opened (often called a bullish candle), and every red candle means the price closed lower than where it opened (often called a bearish candle).

The candlestick chart is by far the most popular type of chart used in forex technical analysis as it provides the trader with more information while remaining easy to view at a glance.

How to Analyse Technical Charts

Charting techniques in technical analysis will vary depending on the strategy and market being traded. It is important to be familiar and comfortable with a particular strategy so that you can implement it accurately. Analyzing the charts according to the strategy will ensure consistency in trading.

Questions to ask before choosing a technical analysis chart type:

What trading strategy is being used？

Is the trading strategy for short, medium or long-term trading？

Once the above questions can be answered, the chart type can be selected using the appropriate information provided.