Technical Analysis Basics: A Guide for Beginners

Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.  is the leading gold-focused royalty and streaming company with the largest and most diversified portfolio of cash-flow producing assets.

what is Technical Analysis

If a stock price dips below an area of support and remains there for a while, that’s usually a sign it will continue to drop. Because momentum indicators measure trend strength, they can serve as early warning signals that a trend is coming to an end. Technical analysts also widely use market indicators of many sorts, some of which are mathematical transformations of price, often including up and down volume, advance/decline data and other inputs. These indicators are used to help assess whether an asset is trending, and if it is, the probability of its direction and of continuation.

Across the industry, there are hundreds of patterns and signals that have been developed by researchers to support technical analysis trading. Technical analysts have also developed numerous types of trading systems to help them forecast and trade on price movements. Technical analysis attempts to forecast the price movement of virtually any tradable instrument that is generally subject to forces of supply and demand, including stocks, bonds, futures, and currency pairs. In fact, some view technical analysis differentiate between fundamental and technical forecasting as simply the study of supply and demand forces as reflected in the market price movements of a security. Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysis, which attempts to evaluate a security’s value based on business results such as sales and earnings, technical analysis focuses on the study of price and volume.

There are dozens of different candlestick formations, along with several pattern variations. It’s certainly helpful to know what a candlestick pattern indicates – but it’s even more helpful to know if that indication has proven to be accurate 80% of the time. The gravestone doji’s name clearly hints that it represents bad news for buyers. The opposite of the dragonfly formation, the gravestone doji indicates a strong rejection of an attempt to push market prices higher, and thereby suggests a potential downside reversal may follow. Caginalp and Balenovich in 1994[58] used their asset-flow differential equations model to show that the major patterns of technical analysis could be generated with some basic assumptions. Some of the patterns such as a triangle continuation or reversal pattern can be generated with the assumption of two distinct groups of investors with different assessments of valuation.

During uptrends, a stock will often hold above the 30 level and frequently reach 70 or above. When a stock is in a downtrend, the RSI will typically hold below 70 and frequently reach 30 or below. The moving average is used to show the direction a price is trending, factoring out short-term price blips.

There will always be an element of market behaviour that is unpredictable. There is no definitive guarantee that any form of analysis – technical or fundamental – will be 100% accurate. Although historical price patterns give us an insight into an asset’s likely price trajectory, that is no promise of success. Fibonacci was a 12th-century mathematician who developed a series of ratios that is very popular with technical traders.

After that, take what you learned and test them with backtesting – simulated trading that allows you to trade without using real money. For example, a currency pair can have significant up- and downswings in price. If the prices fluctuate a lot, it shows high volatility, and a currency pair where prices are stable have low volatility. On most charts, if the horizontal left line is lower than a horizontal line on the right, then the bar will be shaded green, representing a growth period.

  • This can help you to trade reversal chart patterns like head and shoulder.
  • The basic concept behind Bollinger Bands is that overstretched price fluctuations will bounce back like an elastic band.
  • Support levels lie below the current price level, while resistance levels are above.
  • The aim of fundamental analysis is to find the intrinsic value of the asset (stock), so it focuses on factors that can be used to estimate that.

Among various technical trading strategies and indicators, most are based on this second assumption. Including quantitative analysis in fundamental and technical analysis could inform a multifaceted investment strategy. Synergies include multifactor models where the combination of fundamental and technical factors in one model can be used to predict stock returns. Also, quantitative techniques could be used to balance a portfolio based on fundamental and technical criteria.

So savvy traders will buy when there is a momentary drop below that line. The 4-hour chart of USD/SGD below illustrates the value of a momentum indicator. The MACD indicator appears in a separate window below the main chart window. The sharp upturn in the MACD beginning around June 14th indicates that the corresponding upsurge in price is a strong, trending move rather than just a temporary correction.

Congestion areas and previous lows below the current price mark the support levels. A break below support would be considered bearish and detrimental to the overall trend. Many technicians apply a top-down approach that begins with broad-based market analysis, then narrows down to specific sectors/industries, and ultimately analyzes individual stocks. Volume is critical since it validates previously determined trend directions. In technical analysis, the support price is the price at which there are more buyers than sellers.

Judging from the picture of the historical average monthly returns, it may appear wise to look for buying opportunities in October and try to sell in April. But you should know that past performance is not always indicative of future performance. Moreover, seasonality in individual stocks can vary widely from that of the S&P 500 Index. The advance/decline line is used to measure how the stock market is performing.

In addition to using the analysis to guess the future direction of price movements, they also use it to develop some rules about when to enter (or not enter) a trade. In technical analysis, once price data is displayed on charts; specific patterns appear, creating recognizable shares and drawing various trendlines, shapes, and curves. Two main chart pattern types are reversal patterns, which occur when prices change, and continuation patterns, when a trend continues in the same direction. Many investors and traders opt for a blended approach, leveraging the strengths of both.

Even though technical analysis follows predefined rules, the results can be interpreted in many ways and are often subjective. Nevertheless, the blended approach is balanced, offering the depth of fundamental analysis and the real-time applicability of technical analysis. On the other hand, the concept of technical analysis will remain the same irrespective of the asset you are studying. For example, an indicator such as ‘Moving average convergence divergence (MACD) or ‘Relative strength index (RSI) is used the same way on equity, commodity, or currency. One method for avoiding this noise was discovered in 1995 by Caginalp and Constantine[62] who used a ratio of two essentially identical closed-end funds to eliminate any changes in valuation. A closed-end fund (unlike an open-end fund) trades independently of its net asset value and its shares cannot be redeemed, but only traded among investors as any other stock on the exchanges.