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Technical Analysis: A Beginners Guide
“History repeats itself”. Certainly in the stock markets, if we look at past price movements we see patterns repeating over and over again. Technical analysis is a method of categorising those patterns and statistically analysing historical trading data to identify trends to help forecast how a security might perform in the future.
There are a variety of different classes of technical analysis tools and indicators available to use with the charts. The indicators can be grouped as follows:
- Trend lines, Support & Resistance levels and Fibonacci Studies are used to predict where and how a price is likely to move and to identify potential price reversal points.
- Trend Following Momentum Indicators "follow the trend". They are useful in helping to confirm the overall direction of price movement. These indicators are considered “lagging indicators” as they lag behind the current price movement -and so whilst good at keeping you on the right side of the trend, they can be late in signalling buy and sell opportunities. Examples of trending indicators include Moving Average or MACD.
- Momentum Oscillators measure price momentum and oscillate up and down between set limits over a centre line. These indicators are typically “leading indicators”, that is they may give insight into where the price may go in the future. Examples of momentum indicators are RSI and Stochastic.
- Volatility Indicators measure the degree of fluctuation in price movement over a specified timeframe. High volatility means the price is fluctuating dramatically, low volatility means the price is stable and remaining relatively constant. Examples of volatility indicators are Bollinger Bands (which compare a market’s current price to its moving average) and Chaikin Volatility (which compares price to its high-low price range). Volatility indicators are best used in combination with other indicators (eg trend / oscillators) to confirm the direction of the price movement.
It is worth bearing in mind some general pointers when using technical analysis:
- Before using any indicators, it is important to determine the direction of the major trend. Which indicators to use and their interpretation varies depending on whether the security is trending up / down or trading in a sideways range, For example, if the market is trading sideways then Stochastics or RSI are useful in identifying overbought / oversold conditions.
- Set indicator parameters and chart interval to suit your trading style or particular strategy. It is generally suggested to use longer periods if you are long term buy and hold or swing trader. Use shorter periods for day trading.
- Don’t rely on signals from one technical indicator in isolation or signals from a combination of indicators of the same grouping. If a technical indicator gives a buy or sell signal, look for confirmation of the signal from the indicators in other groupings before acting.
The Technical Analysis Guide section provides an introduction to how technical analysis can be interpreted and used to time trades. The descriptions and examples provided are intended as a general guide only and do not constitute advice or recommendation. This is not a definitive guide – there are many other ways to use and interpret the indicators depending on market conditions and personal preference.
It is important to remember that markets fall as well as rise; that all technical indicators are based on past price performance and that past performance is not necessarily indicative of future performance. Before using any indicators you must do your own research.
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