Are you interested in learning the fundamentals of professional technical analysis? if yes, keep reading.
If you are a complete beginner to the trading space, we advise you to start from our forex trading tutorial for beginners.
If you have some basic knowledge of the field, or even have good experience, I am confident that you will find value in this technical analysis basics tutorial.
The information contained in this technical analysis basics tutorial is the essence of accumulated trading and technical analysis experience from several technical experts.
We ask you to be patient while reading, especially in the beginning. If you feel that a topic is not clear, just keep going, it will be clearer by the end of the tutorial.
Note: We are using tradingview as our charting platform for this tutorial.
You can move between chapters through the drop down menu below.
Technical analysis is a method that employs chart analysis tools to forecast possible future price movement.
It is based on one major assumption that freely traded securities (such currencies, shares etc.) travel in trends and shape identifiable repetitive patterns.
This assumption is based on the fact that human feelings, behaviors and reactions are probably repetitive. And economic conditions move in cycles.
And since the price is determined by the people trading it, then the price will tend to have repetitive patterns. (We will discuss this more in the trends section).
Technical analysis is not a science. It is a way of finding tendencies. A “tendency for the price to move in a certain direction”, not “to actually move in a certain direction”.
Expecting sure outcomes from technical analysis forecasting is a great misconception. As expectations are subject to percentage of failure. Looking for holy grail system that generates 90 percent successful outcomes is imaginary.
Also, technical analysis can’t forecast unexpected extreme news events. such as a terrorist attack in Europe, or explosion in an oil field in Nigeria.
Technical analysts analyze and monitor the charts of securities to make trading or investment decisions.
What Are Charts
A chart is simply a visual (graphical) representation of data. It represents the price movement with time. A chart quickly transforms a table of data into a clear visual representation of the information.
Because a technical analyst is mainly concerned with studying the charts to recognize patterns and trends, he is also called “chartist”.
Charts have several benefits for traders, a few of them are:
- By viewing any security’s chart, you can see decades long of price history in few seconds.
- Charts can help you sense the character or behavior of the security you are analyzing. You can spot any repetitive behavior or pattern.
- Using charts is a must if you are planning to create a systematic trading strategy.
- Charts can help you find correlations between several securities.
Few terms before we start:
- Closing price: is the price where the last transaction happened for this security for a specific time frame. For example, the closing price for a “daily” period is the last price of the day.
The time period can be a day, a week, a month, or even intraday such as, one hour, or even one minute.
- Opening price: is the price where the first transaction happened for this security for a specific time frame. For example, the open price for a “daily” period is the first price of the day.
- Highest price: is the highest price that was reached within the period
- Lowest price: is the lowest price that happened within the period.
Charts come in different styles. The main types of charts are line, bar, and candlestick charts.
A line chart is simply a line that connects closing price for the security. For example, if the price of instrument “X” closed the trading day two days ago at $50, and closed yesterday’s trading day at $51, then closed today at $53. We can represent these numbers visually by a line graph that connects closing prices as illustrated in the image below.
This is the most basic chart type. To construct a line chart for any security, you only need the closing price for that security for every time period.
The one-hour line chart is simply a line that connects the closing price (last transaction price) for every hour. While a weekly line chart connects the closing price for every week.
The line charts only provide part of the information, as they only show the closing price of the instrument, ignoring other important information – such as at what price the trading period opened or the highest price that instrument traded at during this period.
The bar charts takes this information into consideration . The bar chart represents the open, close, high and low for the security the specified time frame.
Every bar is a horizontal line. The highest point in the bar is the highest price that was recorded during the time period and the lowest point is the lowest price. The left vertical notch is the opening price of the time period, and the right vertical notch is the closing price.
Note: You can change the time period on the main horizontal toolbar in the metatrader or tradingview platforms.
The candlestick charts are like the bar charts; however, they are just thicker. The horizontal bar is wider and that makes candlestick charts more visual.
If the candle is red or black(filled), then it is a down candle. That means the opening price is higher than the closing price..
If the candle is white, blue (or hollow sometimes), it is an up candle. That means the opening price is lower than the closing price.
The long thin upper and lower lines are the high and low and called shadows or wicks of the candle.
There are two main types of chart scales. The linear and the logarithmic.
The linear scale is the default scale for all charting platforms. Where the vertical price scale, represent the dollar amount change in price. The distance between prices are equal, i.e.- the distance between $1 and $2 is equal to the distance between 9$ and 10$.
This is an example char of both scales of the bitcoin price.
Same chart but on a logarithmic scale :
On the logarithmic scale, the vertical distance represents the percentage change in price.
That is- the distance between $1 and $2 is larger than the distance between $9 and $10. Because the percentage of movement from $1 to $2 is 100%, while from $9 to $10 is near 10 percent. So, the distance between $1 and $2 will be 10 times larger on the chart price scale.
In the below chart, the distance between $190 and $200 is compared with the distance between $460 and $470. While both have $10 change, the distances are different.
The rule of thumb for when to use a logarithmic scale is when the security’s price makes sharp parabolic movement. Also, it is better to use it if analyzing charts with long history. See the long term weekly chart for the same instrument on a linear and logarithmic scale below.
Now let’s dive into the main core of this part. The tools of technical analysis.
Important Note: Most examples we introduce in this tutorial have successful outcomes. However, that doesn’t mean that these tools and patterns are failure-proof, they are NOT. We just don’t see value in showing examples of failed patterns.