1. What is Technical Analysis?
Technical Analysis is based on an examination of past price movements and is a prediction of future financial price movements. Just like weather forecasting, technical analysis does not produce absolute predictions of the future. Instead, technical analysis can help investors predict what may happen to prices over time. Technical analysis uses a variety of charts that can show how prices change over time.
2. How to Use Technical Analysis?
Correct understanding is the key to technical analysis. Technical analysis methods are like a mirror. History repeats itself, but it is by no means a simple repetition. Technical analysis mostly uses statistical analysis as a means, and its analysis results are probabilistic events, not absolute events. Each technical analysis method has its advantages and disadvantages, and each is applicable to a certain market environment rather than all markets. Several key points for making good use of technical analysis methods:
- For each technical analysis method, one should study it carefully and understand it deeply. While mastering the basic application knowledge of the method, one should focus on clarifying its advantages and disadvantages and the applicable market environment.
- Attach importance to the mutual corroboration between different methods.
- Must be mentally prepared that one may make mistakes and correct them.
3. Technical Analysis Methods and Theories
Technical analysis of trading is a method of predicting future price trends by studying historical market data such as prices and trading volumes. The following are some common methods and theories of trading technical analysis:
I. Trend analysis
- Trend line
- Definition: A straight line drawn by connecting a series of price highs or lows, used to judge the direction of the price trend.
- Usage: An uptrend line is a line connecting price lows, indicating that the price is in an uptrend; a downtrend line is a line connecting price highs, showing that the price is in a downtrend. When the price breaks through the trend line, it may indicate a change in the trend.
- Example: In the stock market, if the price of a stock has been rising along the uptrend line, investors can consider buying when the price pulls back to the vicinity of the trend line.
- Moving average
- Definition: A curve obtained by averaging prices over a specific period of time. Commonly used ones include simple moving average (SMA) and exponential moving average (EMA).
- Usage: Short-term moving averages (such as 5-day and 10-day moving averages) are more sensitive to price changes and can be used to judge short-term trends; long-term moving averages (such as 50-day and 200-day moving averages) can better reflect long-term trends. When the short-term moving average crosses above the long-term moving average, it is usually regarded as a buy signal; conversely, when the short-term moving average crosses below the long-term moving average, it may be a sell signal.
- Example: In foreign exchange trading, investors can choose an appropriate combination of moving averages according to the characteristics of different currency pairs to analyze trends.
II. Pattern analysis
- Reversal patterns
- Head and shoulders top/bottom: Composed of three peaks (head and shoulders top) or troughs (head and shoulders bottom). The middle high or low point is higher/lower than those on both sides. When the price breaks through the neckline, it indicates a reversal of the trend.
- Double top/bottom: Composed of two similar highs (double top) or lows (double bottom). When the price fails to break through the high or low point for the second time, a reversal may occur.
- Rounding top/bottom: The price trend is arc-shaped, with the top gradually lowering (rounding top) or the bottom gradually rising (rounding bottom).
- Usage: These reversal patterns usually appear after a period of price increase or decrease and can help investors judge the turning point of the trend.
- Example: In the futures market, if the price forms an obvious head and shoulders top pattern, investors can sell contracts after the price breaks below the neckline.
- Continuation patterns
- Triangles: Including symmetrical triangles, ascending triangles, and descending triangles. The price fluctuates within the triangle and gradually converges. Eventually, it breaks through one side of the triangle and continues the original trend.
- Flags and pennants: Short-term consolidation patterns that appear after a rapid price increase or decrease and resemble flags. After the price breaks through the upper or lower side of the flag or pennant, it continues the original trend.
- Usage: Continuation patterns usually appear during a trend, indicating that the price is taking a temporary break and will continue to develop in the original direction.
- Example: In the stock market, if a stock forms an ascending triangle pattern during an uptrend, investors can buy when the price breaks through the upper side of the triangle.
III. Indicator analysis
- Relative Strength Index (RSI)
- Definition: Measures the strength of market buying and selling power by comparing the magnitudes of price increases and decreases over a period of time.
- Usage: The RSI value fluctuates between 0 and 100. Generally, when the RSI value is above 70, the market is in an overbought state and a correction may occur; when the RSI value is below 30, the market is in an oversold state and a rebound may occur.
- Example: In precious metal trading, investors can combine the RSI indicator with price trends to judge buying and selling opportunities.
- Stochastic Oscillator (KDJ)
- Definition: Composed of three curves: K, D, and J. It judges the overbought and oversold conditions of the market by analyzing the relationship between the highest price, lowest price, and closing price over a period of time.
- Usage: The K and D values fluctuate between 0 and 100, and the J value can exceed 100 or be below 0. When the K and D values form a death cross at a high level (above 80), it may be a sell signal; when the K and D values form a golden cross at a low level (below 20), it may be a buy signal.
- Example: In short-term stock trading, the KDJ indicator is often used to capture short-term buying and selling points.
- Moving Average Convergence Divergence (MACD)
- Definition: Composed of a fast line (DIF), a slow line (DEA), and histogram bars. It judges the market trend by calculating the difference between two moving averages of different speeds.
- Usage: When the DIF crosses above the DEA, it is a buy signal; when the DIF crosses below the DEA, it is a sell signal. The length and color changes of the histogram bars can also provide buying and selling signals.
- Example: In the bond market, investors can use the MACD indicator to analyze the price trend of bonds.
IV. Elliott Wave Theory
- Definition: It believes that the fluctuation of market prices follows a certain law and forms different wave patterns.
- Basic structure: An uptrend is composed of five waves: 1, 2, 3, 4, and 5; a downtrend is composed of three waves: A, B, and C.
- Usage: By identifying the wave patterns and stages, the future price trend can be predicted. For example, after the fifth wave of an uptrend ends, a significant correction may occur.
- Example: In the foreign exchange market, some technical analysts will use the Elliott Wave Theory to analyze the price trend of currency pairs and formulate trading strategies.
V. Volume-price analysis
- Definition: Analyzes the supply and demand relationship and trend of the market by combining price and volume changes.
- Usage: When the price rises and the trading volume expands, it indicates that the market buying power is strong and the trend may continue; when the price rises but the trading volume shrinks, it may mean that the upward momentum is insufficient and there is a risk of a correction. Conversely, when the price falls and the trading volume expands, the market selling pressure is heavy and the trend may continue to fall; when the price falls but the trading volume shrinks, it may indicate that the selling pressure is reduced and there is a possibility of a rebound.
- Example: In the stock market, if a stock’s price is rising and the trading volume continues to expand, it shows that the market demand for the stock is strong and investors can continue to hold; if the trading volume suddenly shrinks significantly, they may need to be vigilant about a price correction.
The above are just some common methods and theories of trading technical analysis. In practical applications, investors should combine multiple analysis tools, comprehensively consider various factors in the market, and formulate reasonable trading strategies. At the same time, technical analysis is not absolutely accurate and there is uncertainty in the market. Investors should also pay attention to risk control.
Reproduction Notes：InvestFancy » Technical Analysis in Trading