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.
If you hit the google search looking for the term “Trend”, one of the first results should be “A general direction in which something is developing or changing”. The trend is a dominant bias in any aspect of life.
For example, we could say that the trend for classic 19th-century men caps is strongly dominant these days. And that basically means that a lot of demand is going on for 19th-century men caps that make them a theme these days, weeks or months.
Demand is always the main driver for any product. Price and supply are the other parts of the equation. The interaction between the three is constantly changing and make up the market.
In the financial markets (Whether in Forex, Stocks, or any other asset class), any financial instrument price is driven by demand and supply.
The instrument is said to be in an uptrend when there is enough demand to make it move higher for a period of time.
What creates those trends is some major underlying fundamental and economic factors. Major factors like monetary policy outlook can impact securities persistently for a period of time, creating long term trends.
Technical analysis is not concerned with the factors behind a trend, or the reasons behind the change in the prices of the instrument under analysis.
The reasons behind the price movement can vary widely, from political, economical, investors expectations and emotions, and many more. In most cases, these factors, and their interpretation can’t be accurately expected or gauged.
Technical analysis is concerned with the price itself as it reflects all these factors(price discounts everything) and therefore no additional information is necessary.
Studying the price movement for decades, practitioners observed a repetitive behavior that is dominant across all asset classes. The main cornerstone for technical analysis is based on this one main idea of trends.
The most basic and fundamental assumption that technical analysis relies on is that the prices of freely traded securities that have sufficient trading volume -move in trends and trends tend to continue rather than reverse.
Technical analysis is the art of identifying a trend at an early stage and maintain a trade position until evidence indicate that the trend has reversed.
Simply stated, a trend is a directional movement of the price that can be to the upside, downside, or just horizontally(Sideways).
The directional trend is a dominant motion in one direction that is interrupted by smaller moves in the opposite direction, these opposite moves are called corrections or pullbacks(We will discuss corrections further later in this tutorial).
In many instances, a trend can be spotted by bare eyes. However, for professional technicians, it’s not just about the general directional move. The practitioner needs to be more specific . let’s discuss the structures for each trend type.
Directional Uptrend And Downtrend
An uptrend, also called bullish trend, in its general definition is a directional move to the upside that can be spotted visually. Technically, an uptrend should have a distinctive structure of consecutive waves, where each wave surpasses the prior wave.
An uptrend is a series of higher highs(peaks) and higher lows(troughs). Where each high surpasses the previous high, and each low is above or equal to the prior low. Each major upside wave is followed by a downside correction.
A Downtrend, also called a bearish trend is the exact opposite of an uptrend. It is a series of lower highs and lower lows. Where each low surpasses the previous low and each high is lower or equal to the prior high.
– The terms peak, high or swing high have the same meaning. As well as trough,low and swing lower.
– The terms up equals bullish and down equals bearish.
We will be using all these terms interchangeably throughout the tutorial.
Before moving to a real-life trend example, we need to explain three more key concepts, support & resistance, breakouts and corrections.
Support & Resistance
The troughs and peaks that the price establishes -while trending-are support and resistance levels.
These levels are extremely important as they reflect a change of equilibrium between supply and demand. Indicating a shift of psychology from a selling interest to buying interest or from buying interest to selling interest.
Support and resistance determine when trends have reversed in the past and are a clue as to when they will reverse in the future.
For instance, if supply is higher than demand, the price of an instrument falls. As the price reaches a support level below, demand increases again to exceed supply forcing the price to reverse direction and move higher.
The opposite is true for resistance. If the price was rising due to higher demand, the area at which the price reverses to the downside reflects a change from higher demand to higher supply and thus the price reverses direction, making this level as resistance.
Support and resistance are levels where the price tends to stop and reverse direction. Resistance is a level above the price, where supply gets strong enough to exceed demand, forcing the price to move back lower.
Oppositely, support is a level below the price. where demand gets strong enough to exceed supply, forcing the price to move back higher.
Resistance usually turns to support when a breakout completes(Breakout means penetration. We will explain what is a breakout shortly),as illustrated in the chart below. The opposite is true when a breakout below support materializes, support usually turns into resistance. This is a very important phenomenon.
Here is a real life chart example:
Support and Resistance Zones
When the price forms multiple highs or lows near but not at the exact level then the whole area should be marked support or resistance, and it is called a support or resistance zone.
A picture is worth a thousand words. Here is an example chart:
What is a Breakout?
A breakout is simply a move beyond a price level – typically a support or a resistance. A breakout usually signals a major move ahead or a change of a trend.
Many technicians have their own methodology in identifying a valid breakout. For some traders, a breakout above or below a level is merely the price ability to trade above or below that level.
For example, if a trader identifies 1.3000 as an important level for the EURUSD, and the price trades just above that level at 1.3001, he/she might consider this a valid breakout! Although this approach might be valid for some, it’s not optimal.
The Closing Filter
Many technicians use the closing technique to confirm a valid breakout. Simply stated, the price must close above or below a specific level on the time interval being analyzed to confirm a valid breakout.
We prefer this method. For a breakout to be valid there should be a CLEAR closing above or below the level for the time interval being analyzed.
The Percentage Filter
Another method traders use is based on the price ability to move minimum percentage points beyond a certain level. An arbitrary number of 1 or 2 percent is common.
However, it’s is more efficient to decide on this percentage based on the nature of the underlying instrument under analysis. For example, some instruments are more volatile than others and may require a wider filter of 3 percent.
A false breakout is simply when the price of an instrument successfully breaks below/above support or resistance but fails to maintain the move for a sufficient distance, and the moves back in the opposite direction.
Specialist breakout is a form of false breakout. It is called specialist because it is believed that this breakout is a result of manipulation from big players in the market, such as big market makers. Where the price breaks a significant resistance or support level, to trigger stop loss order placed above or below that level, then move back in the opposite direction leaving traders with loss.
Also forcing the public to believe that the price is heading in the breakout direction, then they would sell to make profit.
Forex Directional Trend Chart Example
Let’s get back to our directional trends. Here is a real-life example of a Downtrend on NYMEX Crude Oil Daily Chart. This chart example is intended to help you identify the downtrend correctly(Same procedure goes for an uptrend).
It might look confusing at first sight, however, if you start reading the chart from the left-hand side and move with the price action it should make sense in no time.
If you start from the left-hand side of the chart and move forward with the price action, you will notice the clear structure of lower highs and lower lows(Downtrend). Which was maintained for the whole period we examined.
Note that in mid-October, there was a move higher beyond the prior swing high. But, for us, that wasn’t a valid breakout as the price has marginally closed above the previous high. Therefore the structure of the downtrend(lower highs and lower lows) was still intact.
As mentioned earlier, for the breakout to be valid, it should be clear and noticeable. If it doesn’t scream a breakout, do not take it.
Forex Sideways Trend
When the price movement go undefined, where a technician can’t spot any series of uniform higher highs and higher lows(uptrend). Or lower highs and lower lows(downtrend). Then it is a sideways trend.
When the highs and lows are mixed without a clear sequence, and they appear roughly near the same level, that would result in a horizontal movement and a shape that looks similar to a rectangle. In that case, the market is said to be sideways, flat, ranging, or trend-less. All names have the same meaning.
Here is an illustration of a sideways trend.
In the NYMEX Crude Oil chart example above, there was a period where the price entered a sideways trend. It was a part of the overall downtrend. Zooming into this period between September and early November we can extract the following sideways trend chart example:
A breakout of the sideways range in any direction usually signals a trading opportunity and a change in the trend.
Trends are Fractal
A fractal is a repetitive pattern. Fractals are infinite patterns that are self-similar across different scales.
Trends of different lengths tend to have the same characteristics. In other words, a trend in annual data will behave the same as a trend in five-minute data.
As a trader or investor, you must choose which trend is most important for you based on objectives and personal preferences, and the amount of time you can devote to watching market.
The chart above is a clear illustration of the fractal nature of trends. You can see multiple short term trends within one longer-term trend. If you zoom further into the price action, you will find inside these short term trends shorter trends and so on.
REMEMBER: Long term trends are more reliable than short term ones. This is a general rule of thumb in technical analysis and for any technical analysis tool. The shorter the time interval the more unexpected and noisy it is. Why?
As I mentioned earlier in this tutorial, major and dominant demand trends are a result of major fundamental factors, these factors are usually persistent. While, in the short term, the price can be affected by any temporary factors, such as misinterpretation of data, irrational exuberance or false news.
Although the trend concept is easy to understand, its application is difficult and tricky.
Determining when that larger trend is reversing is a tough decision. Because the price oscillates back and forth in smaller trends along its travel in the larger trend. Therefore, any signs of reversal may only be for smaller trends(corrections) within the larger trend.
REMEMBER: Several technical analysis studies and research found that an actual trend lasts only a short time. Probably less than 30 percent of the trading period. During the remaining time, prices remain in an indefinite trend or sideways trends.
While there is no study of the accuracy of this percentage, the main idea to keep in mind is that as a trader you should anticipate periods of sideways movement more than anticipating a uniform up or downtrends.
We will cover retracements in greater details later at this tutorial. For now, we need to understand some basic concepts.
Corrections are moves in the opposite direction of the overall trend that contains them. A correction can be seen as another trend with a smaller magnitude.
A correction or also called retracement, in a trend, can provide a new opportunity for the trend trader who missed the initial wave in the longer-term trend to jump onto it.
The stronger the trend, the shorter the retracements are. When the trend is strong, the corrections are usually short lived and limited to above 50% of the main trend.
Usually, but not always, breakouts are followed by retracements. i.e. sometimes the price breaks a support level to the downside and following the breakout it retraces back higher towards the broken support to retest it. This process is called a pullback.
Throwbacks are the opposite of pullbacks. The price breaks a resistance level and then retraces back lower to retest the broken resistance.
Note: You do not have to worry about the lingo. It is enough to know that both are retracements.
Note that the price may fail short just ahead of the support or resistance and resume the move in the direction of the breakout.
Trend Structure Break
We have just explained in the previous part this method of identifying trends using the peaks/troughs. This is the most important and widely used method. We mentioned that the trough and peaks are potential support and resistance levels. So what if the structure breaks?
A key warning the trend could be reversing or stalling is a breakout below the latest trough in an uptrend. Or latest peak in a downtrend.
While this break doesn’t guarantee a trend reversal(just like any other technical development), it is an important development that should be considered in your decision-making process.
Breaking the latest trough in an uptrend or peak in a downtrend is important by definition, as this break will invalidate the uptrend or downtrend structure. Thus, the price no longer has the structure of higher highs and higher lows and therefore the trend could be reversing.
Here is a chart example of a clear downtrend structure that was violated by breaking the latest high.