Technical analysis uses recognizable chart patterns and statistical indicators to predict market dynamics. It is assumed that its price determines the market’s opinion on an asset at a given point in time.
Fundamental financial variables, such as earnings per share or government data, are not factored into technical analysis. Strict adherence to the principles of technical analysis is designed to eliminate the error of subjective interpretation. The goal is to form an objective assessment of the market, excluding emotional factors that can influence the decision-making process.
Basic technical analysis tools
Support and resistance levels are the main components of Daily technical analysis. Support levels are any prices below current prices that could prevent the market from falling. Resistance levels, by contrast, are marks that can limit rallies.
An example of a resistance level could be the 52-week high. Accordingly, the 52-week low is often a support.
Types of technical analysis
Chart analysis suggests that market dynamics will repeat if a previously observed pattern occurs. Experts distinguish between classic and candlestick patterns, as well as Elliott waves.
- Classic patterns have been used for many decades to find patterns of continuation and reversal. The former include pennants, flags, and triangles, while the latter include double and rounded extremes and a head and shoulders (H&S) pattern.
- Elliott Wave Analysis depends on the Golden Ratio of the Fibonacci series to identify 5-wave trends and 3-wave corrections.
- Candlestick analysis uses open and close levels, as well as highs, lows of certain periods (days, weeks, etc.), which helps to identify patterns of continuation (bullish candles with a long body) or reversals (hammers and shooting stars). Each type of template has its methodology for identifying support and resistance levels and possible price movements.
Simple moving average
Another technical indicator used by analysts is the Simple Moving Average, which is the average price of an instrument over a period. For example, the 8-day moving average is the average closing price of each last eight days.
As the name suggests, the monitored series changes over time, forming a line on the charts, showing the market’s direction; in a bull market, prices are above average, and in a bear market, they are lower.
The moving average line itself can act as support or resistance if the market shows an appropriate reaction to its testing. Additional signals are generated when moving averages cross. For example, a bearish signal will appear if the 8-period moving average crosses down the 40-period moving average. Weighted and exponential averages are also used in technical analysis.
Oscillators are more complex technical indicators. They take a neutral value in the middle of their range (around zero or 50, depending on the indicator). Extreme values signal overbought or oversold conditions. This category includes the Stochastic Oscillator, Relative Strength Index (RSI), MACD, momentum, and many others.
Each of these indicators is bullish on gains and bearish on declines. The intersection of the centerline confirms the direction. RSI and Stochastic Oscillator take values from 0 to 100; above 70, the market is considered overbought, and below 30 is oversold. Another important category is trend indicators such as the Average Directional Movement (ADX) indicator. They allow you to determine the strength of the impulse and assess the likelihood of reaching target levels, which are determined separately for each pattern. These indicators do not reflect specific levels or direction but help analysts assess the likelihood of continued movement.