- Basic principles of technical analysis
- Chart analysis is your compass in financial markets
In this series, we will explore technical analysis (TA) as one of the methodology that is commonly used in market analysis. In TA, we will study the balance of demand and supply ratio and its strength using various tools available. One of the common pitfalls of newcomer in this field is that they either attempt to use a single tool in isolation or crowding their charts with too many tools. You heard the common sense phrases that things don’t exist in a vacuum and too many cooks spoilt the soup. All we need is the tools that are working for us.
There are a few basic principles of TA:-
- The discounting mechanism of the market
- Prices move in trends
- History tends to repeat itself
- Emotion is one powerful force in the market
- Market has structures in itself
- Multiple time frames exist in the market simultaneously
- Price, volume and time are the key data for analysis
The discounting mechanism of the market
Technical analysts believe that almost all the relevant information is already reflected in the prices. The market represent the summation of all market participants view of the future in regards to fundamental expectation, hope, fear, greed, economic forecast, political outlook, news update and other factors. This is an important point to remember. Many of times newcomers long the stock on the release of good earnings report only to find the stock price drifts downward or shorting the market on bad news only to find the market rally up after a short dip. This is the discounting mechanism at work.
Prices move in trends
Trend analysis is vital in TA. It provides the overall direction of the market prices. Most of the time, the market is either in trending or in consolidating mode. Trending is the action of moving in the primary price direction and consolidating or more commonly referred to as correction moves in counter direction or in sideways. So basically the market will either trend up, trend down or moves in sideways. The main juices of profits come from trading with the trend. Of course there are other strategies that can be used during market sideways movement. We will talk about trading methods to be used during trending and also sideways movement later.
History tends to repeat itself
"Kingdom comes, kingdom goes but human nature remained the same." This famous Chinese saying is on the dot referring to history repetition. Human is the creature of tendencies and habits. Support and resistance levels are the evidences that human remember their experiences. The basis that history repeats is the foundation of TA which is the analysis of historical data to forecast future movements. The dejavu experience is very common for any technical analyst.
Emotion is one powerful force in the market
Money is an emotional subject. Fear and greed are the most powerful emotions found in the market everyday. Greed is the motivation of people wanting to profit from the most lucrative financial markets. At the same time fear of losing their money grips them. The fluctuations in the market prices are the results of such emotions in battle. Such emotions exist in all of us with variation in strengths and grips. We can’t get rid of them but we can manage them actively or passively. There are tools that we will study later to help us manage our emotions in trading.
Market has structures in itself
Believe it or not, markets do have structures. Just like human, the market has its own life, heart beat and structure. It is as though an invisible Hand is guiding it through the motion of time. Although not all technical analysts are agreeing to this, those that are looking at it in depth will be surprised to see patterns of this occurring so often to be ignored. Market moves within the scope of the structure in place and the understanding of such structures will enable us to have a better trading edge. We will discuss more of the structure analysis methodologies that are available to us later in our series.
Multiple time frames exist in the market simultaneously
Time frame perspectives are very important in analyzing the market as the market exists in multi time dimensions. Generally the term bull or bear trend is deceiving to many even to most technical analysts. We have to look at the market at certain time perspective because in a weekly chart the market could be trending downward but in the daily chart is trending upward. Traders will need to define their trading time frame in their trading plan. Different trading styles ranging from scalpers, swing traders, day traders and position traders are examples of trading strategies customized to various time frame of the market. Integrating various time frames in analysis will definitely tell a story about the market. We will cover those techniques in time to come. Various trading styles will also be covered too.
Price, volume and time are the key data for analysis
Any transaction that takes place will be having price, volume and time information. These data are the key information used in TA to derive to trading decision. Most technical analysts are relying on the price information only in their analysis. Few technical analysts will incorporate volume information to get a better trading edge. Even fewer sophisticated traders incorporate time information in their analysis. Most indicators used such as moving averages are price based indicators. We will cover these few trading analysis methods as we go. Let our journey begin.
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