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Introduction to technical analysis

Essence and history of technical analysis, basic methods of technical analysis, graphical methods of technical analysis (levels, reversal figures, continuation figures), trend indicators (moving averages, MACD, ADX), oscillators( RSI), Candle Stick

1. Essence and history of technical analysis

2. Basic methods of technical analysis

3. Graphical methods of technical analysis (levels, reversal figures, continuation figures)

4. Trend indicators (moving averages, MACD, ADX)

5. Oscillators( RSI)

6. Candle Stick

7. Elliott wave analysis

1. Essence and history of technical analysis

Technical analysis — a popular way among traders to predict the behavior of the price of an asset in the foreign exchange market. Technical analysis is based on the belief that price changes that have occurred in the past are inevitably repeated.

Confirmation of previously recorded patterns in the behavior of the market is sought through the analysis of price charts, during which certain graphic figures are identified, interpreted as signs of a possible price movement in one direction or another.

The central position of technical analysis is the assertion that prices take into account everything. That is, there is no need to monitor and analyze economic news, since all of them are already reflected in the price, just look at the chart. The logic in this case is the following: if the market makes figures (price values) from information, then there must be a possibility of the reverse process of obtaining information from figures (prices).

Price forecasting on the basis of technical analysis is based on the data (results) of previous trades, the most important of which are:

- prices;

- trading volumes.

History

There are two approaches to understanding the history of technical analysis. The first of them is based on the opinion that the technical analysis originated in the United States and, accordingly, is a creation of Western thought, while others believe that the technical analysis originates in the East. Let's briefly consider each of these versions.

The first mention of the possibility of forecasting future price movements based on the results of previous trades appeared in the late XIX century in the Wall Street Journal. This was a note already notorious Charles DOE-creator of the now popular Dow Jones index. The theory created by Dow exists to this day and is called: "Dow theory". The method developed and improved until the 1970s. With the advent of computers, it became easier not only to count, but also to display calculations in a graphical form.

According to the second approach to understanding the history of technical analysis, it originated in ancient Japan. While Columbus didn’t even think of discovering America, the first prototypes of stock exchanges in which rice was traded existed in Japan. And the Japanese traders, trying to predict the movement of prices, drew the Candle Stick with chopsticks on the sand, looked for their specific combinations, which were repeated and predicted the price changes of rice.

Basic postulates of TA

1. Movements in asset prices include all factors.

2. Prices move in a directional manner. This means that price movements aren't random and move in a certain direction. Directional movement is called a trend. There are three types of trends: bullish (upward movement), bearish (downward movement) and flat (prices move in a certain range).

3. History repeats itself. This postulate is based on the existence of patterns - typical structures that reflect the price dynamics and occur from time to time. Their existence is associated with the peculiarities of human psychology.

As additional, they also distinguish:

- indexes must confirm each other - any trading signal has to be confirmed (generated) by signals from other indexes (indicators).

- trading volume should confirm the trend - trading volume should increase in the direction of the main trend.

- trend exists until obvious signals appear, it has changed.

A characteristic feature of technical analysis is its applicability to prices in all types of markets. In commodity markets, technical analysis is just as applicable to the prices of gold, oil and natural gas as far as coffee and sugar prices are concerned. In financial markets, you can also successfully work with rates of different currencies, as well as with different indices. In fact, any process, on the graph of which the trends are viewed, can be analyzed by methods of technical analysis.

2. Basic methods of technical analysis

There are three different approaches to analyzing price charts. The first is superficial, subjective. It is based mainly on intuition. It doesn't require any rigorous analysis or justification, so most traders work at this simplest level. Unfortunately, they sacrifice logic for the sake of simplicity and convenience.

The second approach is related to the creation of market indicators that help determine trends, oversold and overbought market conditions, price deviation from equilibrium, etc.

The most effective and valuable is the third approach - the development of trading systems that can generate signals for buying and selling. However, not all analysts have sufficient level of education, experience and the desire to constantly sharpen their skills.

The main methods of technical analysis include the following:

1. Graphical

- levels;

- graphic figures;

- candle analysis;

2. Mathematical

- Analysis using average

- Trend indicators

- Oscillators

3. Elliott Wave Theory

3. Graphical methods of technical analysis (levels, reversal figures, continuation figures)

Types of graphical display of prices

• Tick chart

• Line chart

• Bar chart

• Candle Stick

Support level

This is a level of prices when the down trend begins to move in the opposite direction.

That is, from the level of support it is recommended to open long positions - to buy

Resistance level

This is a level of prices, at which the upward trend begins to move in the opposite direction.

That is, from the resistance level it is recommended to open short positions - to sell

Trend line

Trend lines are used to identify and confirm the presence of a directed movement of prices (trend). Highlights ascending and descending trend lines

Channels

The combination of support and resistance levels with trend lines leads to the appearance of an interesting method of graphical analysis - channels.

A channel is a special case of construction of support and resistance lines under condition of presence of a trend when these lines are parallel.

Trading rules in this case are similar to the rules of working with levels-from the support line you need to buy, from the resistance line-sell

Graphic figures

Graphic figures - patterns that are formed by price movements for a certain period.

There are two types of graphic figures:

- reversal;

- continuation.

Reversal called graphic shapes, the appearance of which indicates a possible trend change, its reversal. The most important reversal figures are "head to shoulders", reversed "head-and-shoulders ", double bottom and double top, triple bottom and triple top.

« Head-and-shoulders »

Double top

Continuation figures

In contrast to the reversal figures, the trend continuation figures confirm the current trend and signal the beginning of the activation of the price movement after the period of their consolidation. The most important among the graphic figures of the continuation of the trend are triangles, flags and pennants, rectangles and and suchlike.

Triangle

4. Trend indicators (moving averages, MACD, ADX)

Moving Average

Moving Average - is a tool for smoothing time series and represents, in general, the average value of prices for a certain period.

Depending on the specifics of the calculation, several types of moving averages are distinguished:

- Simple Moving Average (SMA) - calculation of a simple arithmetic mean for a certain period;

- Weighted Moving Average (WMA) - SMA modification with weights matched so that the latest prices are more weighty;

- Exponential Moving Average (EMA) - also uses weights, but unlike WMA, it involves not only the previous price values, but also the average values of these prices for a certain period.

Fibonacci numbers

The numerical sequence is 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 (further to infinity).

The Fibonacci sequence has very interesting features, not the last of which is an almost constant relationship between numbers.

The sum of any two adjacent numbers is equal to the next number in the sequence. For example: 3 + 5 = 8; 5 + 8 = 13, etc.

The ratio of any number of sequence to the next approaches 0.618 (after the first four numbers). For example: 1: 1 = 1; 1: 2 = 0.5; 2: 3 = 0.67; 3: 5 = 0.6; 5: 8 = 0.625; 8: 13 = 0.615; 13: 21 = 0.619, etc. Notice how the value of the ratios oscillate around 0.618, and the range of fluctuations gradually narrows.

The ratio of any number to the previous one is approximately equal to 1.618 (the reciprocal of 0.618). For example: 13: 8 = 1.625; 21: 13 = 1.615; 34: 21 = 1.619. The higher the numbers, the closer they are to the values of 0.618 and 1.618.

Signals supplied by averages

The general rules for the analysis of simple averages include the following:

- find the intersection points of the average and the price chart;

- find the points following the maximum or minimum of the mean (turning points);

- find the points of the greatest discrepancy between the average and the price chart;

- follow the general direction of traffic medium. This is the most important signal showing the direction of the trend.

Bollinger Lines

This indicator characterizes abnormally sharp deviation of the price from the current trend.

The trend here refers to the moving average.

BB lines are built as a strip around the middle.

The width of the band is proportional to the root mean square deviation from the moving average over the analyzed period of time.

Trend indicators

Trend indicators - a specific class of technical analysis indicators designed to identify the presence and direction of the trend, as well as the stage of its development.

The most common trend indicators are MACD, ADX and Parabolic SAR.

MACD indicator

It is a combination of two exponentially smoothed moving averages. The first one reflects the difference between exponentially smoothed moving averages, one of which has a period of 12, and the other is 26. The second line (also known as the signal line) is the approximate equivalent of an exponentially smoothed moving average with a period of 9.

The basic rule of working with the MACD indicator is to find the intersection points of the indicator lines with the zero line - the intersection from the bottom to the top generates a buy signal and the top-down signal generates a buy signal

5. Oscillators (RSI)

As the statistics testify to 2/3 of the time the market is in a state of non-directional movement (flat or range). That is, prices fluctuate in a certain range without a clear trend. To work in such conditions, a special class of indicators was developed - oscillators.

Oscillators are a class of indicators of technical analysis that characterize the state of overbought or overvalued markets. That is, they help determine the upper and lower limits of the range, in which the price is now fluctuating.

The most common indicators of the class oscillators are Momentum, Stochastic and Relative Strength Index (RSI). The principle of operation of most oscillators is the same - buying in oversold zones and selling in overbought zones. Areas of overbought and oversold are critical values of the indicator, the excess of which indicates the achievement of the upper / lower limit of the price range.

6. Candle Stick

The analysis of Candle Stick is based on the analysis of combinations of different types of Candle Stick.

A typical Candle Stick consists of a body (characterizes the difference between opening and closing prices) and shadows (show the maximum and minimum prices for a certain period).

Depending on the ratio of body size and shadow, different types of Candle Stick is distinguished: hammer, star, doji, hanging and others.

Combinations of different types of candles can act as signals of a reversal or continuation of a trend. Each combination has its own specific, often poetic, name: the shooting star, the tatami, the two ravens, the evening doji star, and so on.

Morning star

7. Elliott wave analysis

It is a theory of cycles and is more developed on the theoretical than on the practical level. It studies the regularities of cyclical fluctuations of various processes, including the movement of exchange prices. By determining the phase of the cycle of price movement, conclusions are drawn regarding its future movement

Bibliography

• Eric Naiman "Small Encyclopedia of Trader";

• Thomas Demark "Technical analysis - a new science";

• John Murphy "Technical analysis of futures markets. Theory and practice";

• Jack Schwager "Technical analysis. Full course ";

• Steven Akelis "Technical Analysis from A to Z";

• Steve Neeson "Beyond the Limits of Candle Stick." New Japanese methods of graphical analysis ".