A successful trader studies human nature and does the opposite of what the general public does.

W.D. Gann

Technical Analysis Introduction

Technical analysis is a trading discipline employed to evaluate stocks, cryptocurrencies, bonds, FX, commodities, futures, options, precious metals and all other securities that are available to buy or sell on an exchange. Technical analysis at it’s core is the study of financial market price action and is utilized by traders to analyze statistical data gathered from trading activity such as price movement, price trend, price momentum, price volatility and volume which are displayed in graphic form, called charts. Technical analysis can be used on any security with historical trading data, and any timeframe can be analyzed from minute-to-minute or hour-to-hour(for the short-term intraday scalp traders), day-to-day or week-to-week(for the trend, momentum and swing traders), and finally month-to-month or year-to-year charts can be studied(for the long-term investors). Traders who read price charts only are called chartists, while traders who read price charts and derivatives of price(technical indicators) are called technical analysts, or technicians for short.

While fundamental analysts focus on a security’s value based on results such as sales and earnings, technicians focus on the study of price and volume rather than the fundamental factors that (appear to) effect market prices. Technicians operate in markets under the assumption that even if all relevant information of a market or security was known, the markets reaction to that information would still be unpredictable. Technicians believe that there are so many fundamental factors in play at any given time that coming to an accurate assessment of a securities value is nearly impossible. The technical analysist believes that all relevant market information is reflected in price at any given time with the exception of unexpected natural disasters or man-made events, known as black swans. These events are usually discounted very quickly, however, ultimately ending with price returning to the level it was prior to the event.

When one watches financial markets on a regular basis it becomes clear that there are trends, momentum and patterns that repeat over time in the charts, not always identically, but similar. “History doesn’t repeat, but it rhymes” is an appropriate phrase to remember since charts are self-similar as they show the same fractal structure. A fractal is a tiny pattern, a curve or geometric figure, each part of which has the same statistical characteristic as the whole; self-similar means that the overall pattern is made up of smaller versions similar to itself at a different time, or to a copy of itself on a different scale. A price chart is a reflection of the mood of the crowd and not of the fundamental factors, meaning technical analysis is the study of human mass psychology, also known as behavioral finance. When you are viewing a chart, you are viewing the emotions of the traders behind that security rather than the actual value of the security itself. The greed, the fear, the optimism, the despair… charts are visual representations of traders’ emotions.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

Warren Buffet

What Are Candlestick Charts?

candlestick chart (also called Japanese candlestick chart) is a style of financial chart used to describe price movements of a securityderivative, or currency. Each “candlestick” typically shows one day, thus a one-month chart may show the 20 trading days as 20 candlesticks.[1] Candlestick charts can also be built using intervals shorter or longer than one day.

It is similar to a bar chart in that each candlestick represents all four important pieces of information for that day: open and close in the thick body; high and low in the “candle wick”. Being densely packed with information, it tends to represent trading patterns over short periods of time, often a few days or a few trading sessions.[2]

Candlestick Creator

Munehisa Honma (本間 宗久, Honma Munehisa) (also known as Sokyu Honma, Sokyu Honma) (1724-1803) was a rice merchant from SakataJapan who traded in the Dojima Rice market in Osaka during the Tokugawa Shogunate. He is sometimes considered to be the father of the candlestick chart.

Around 1710, a futures market emerged for rice, which had previously been traded exclusively on the spot. This system used coupons, promising delivery of rice at a future time. From this, a secondary market of coupon trading emerged in which Munehisa flourished. Stories claim that he established a personal network of men about every 6 km between Sakata and Osaka (a distance of some 600 km) to communicate market prices.[1]

In 1755, he wrote (三猿金泉秘録, San-en Kinsen Hiroku, The Fountain of Gold – The Three Monkey Record of Money), the first book on market psychology. In this, he claims that the psychological aspect of the market is critical to trading success and that traders’ emotions have a significant influence on rice prices. He notes that recognizing this can enable one to take a position against the market: “when all are bearish, there is cause for prices to rise”[2] (and vice versa).

He describes the rotation of Yang (a bull market), and Yin (a bear market) and claims that within each type of market is an instance of the other type. He appears to have used weather and market volume as well as price in adopting trading positions.

“Why was one of these men able to amass a fortune, while the other never acquired more than a few thousand dollars at the same pursuit?”


Richard D. Wyckoff

What Are Trend Lines?

In finance, a trend line is a bounding line for the price movement of a security. It is formed when a diagonal line can be drawn between a minimum of three or more price pivot points. A line can be drawn between any two points, but it does not qualify as a trend line until tested. Hence the need for the third point, the test. Trend lines are commonly used to decide entry and exit timing when trading securities.[1] They can also be referred to as a Dutch line, as the concept was first used in Holland.

support trend line is formed when a securities price decreases and then rebounds at a pivot point that aligns with at least two previous support pivot points. Similarly a resistance trend line is formed when a securities price increases and then rebounds at a pivot point that aligns with at least two previous resistance pivot points. Stock often begin or end trending because of a stock catalyst such as a product launch or change in management.

Trend lines are a simple and widely used technical analysis approach to judging entry and exit investment timing. To establish a trend line historical data, typically presented in the format of a chart such as the above price chart, is required. Historically, trend lines have been drawn by hand on paper charts, but it is now more common to use charting software that enables trend lines to be drawn on computer based charts. There are some charting software that will automatically generate trend lines, however most traders prefer to draw their own trend lines.

“The man who begins to speculate in stocks with the intention of making a fortune usually goes broke, whereas the man who trades with a view of getting good interest on his money sometimes gets rich.”

Charles Dow

What Are Moving Averages?

In statistics, a moving average (rolling average or running average) is a calculation to analyze data points by creating a series of averages of different subsets of the full data set. It is also called a moving mean (MM)[1] or rolling mean and is a type of finite impulse response filter. Variations include: simple, and cumulative, or weighted forms (described below).

Given a series of numbers and a fixed subset size, the first element of the moving average is obtained by taking the average of the initial fixed subset of the number series. Then the subset is modified by “shifting forward”; that is, excluding the first number of the series and including the next value in the subset.

A moving average is commonly used with time series data to smooth out short-term fluctuations and highlight longer-term trends or cycles. The threshold between short-term and long-term depends on the application, and the parameters of the moving average will be set accordingly. For example, it is often used in technical analysis of financial data, like stock pricesreturns or trading volumes. It is also used in economics to examine gross domestic product, employment or other macroeconomic time series. Mathematically, a moving average is a type of convolution and so it can be viewed as an example of a low-pass filter used in signal processing. When used with non-time series data, a moving average filters higher frequency components without any specific connection to time, although typically some kind of ordering is implied. Viewed simplistically it can be regarded as smoothing the data.

Don’t take action with a trade until the market, itself, confirms your opinion. Being a little late in a trade is insurance that your opinion is correct. In other words, don’t be an impatient trader.

Jesse Livermore

What Is Volume?

Volume Analysis (also referred to as price–volume trend and volume oscillators) is an example of a type of technical analysis that examines the volume of traded securities to confirm and predict price trends.[1][2][3]Volume is a measure of the number of shares of an asset (such as a stock or bond) that are traded in a given period of time.[1] As one of the oldest market indicators used for analysis, sudden changes in volume are often the result of news-related events.[4] Commonly used by chartists and technical analysts, volume analysis is centered on the following ideas:[2]

  • When the volume of a security is increasing or at a relative peak, the current trend in price is confirmed and is said to have momentum
  • When the volume of a security is decreasing or at a relative minimum, the current trend in price is fragile and is said to lack momentum

Volume analysis is used to confirm and predict price directions.[3] The theory behind volume analysis rests primarily on the assumption that a high trade volume signals market consensus behind the corresponding movement in price, and thus that the trend in price is likely to continue.[5] Conversely, a comparatively low volume is interpreted as an indication that the market does not agree with the current price behavior, and is a possible signal of a price trend reversal.[5] In a more applied context:

  • a distinctive increase in price with a distinctive increase in volume might signal the continuation of a bullish trend of a bullish reversal[1]

Conversely,

  • a distinctive decrease in price with a distinctive increase in volume might signal the continuation of a bearish trend of a bearish reversal[1]

In addition to analyzing the fluctuations in volume of a single security, analysis is also often performed on the market volume as a whole. In this way, individual trends in an asset’s price and volume can be discerned from the trends of the market as a whole.[1]

“The most important thing is how good are you at risk control… every day I assume that every position I have is wrong.”

Paul Tudor Jones

What is the Price Percent Oscillator?

The Price Oscillator indicator (PPO) is a technical analysis tool, used for measuring momentum that is very similar to the MACD. The MACD employs two Moving Averages of varying lengths (which are lagging indicators) to identify trend direction and duration. Then, MACD takes the difference in values between those two Moving Averages (MACD Line) and an EMA of those Moving Averages (Signal Line) and plots that difference between the two lines as a histogram which oscillates above and below a center Zero Line.

PPO is exactly the same, however it then takes the same values at the MACD and calculates them as a percentage. The purpose of this, is that it makes value comparisons much more simple and straightforward over longer durations of time.

The Three Major Components

THE PPO LINE
  • PPO Line is a result of taking a longer term EMA and subtracting it from a shorter term EMA. The result is then divided by the longer term EMA and then multiplied by 100.
  • The most commonly used values are 26 days for the longer term EMA and 12 days for the shorter term EMA, but it is the trader’s choice.
THE SIGNAL LINE
  • The Signal Line is an EMA of the PPO Line described in Component 1.
  • The trader can choose what period length EMA to use for the Signal Line however 9 is the most common.
THE PPO HISTOGRAM
  • As time advances, the difference between the PPO Line and Signal Line will continually differ. The PPO histogram takes that difference and plots it into an easily readable histogram. The difference between the two lines oscillates around a Zero Line.
  • When the PPO histogram is above the Zero Line, the PPO is considered positive and when it is below the Zero Line, the PPO is considered negative.

A general interpretation of PPO is that when PPO is positive and the histogram value is increasing, then upside momentum is increasing. When PPO is negative and the histogram value is decreasing, then downside momentum is increasing.

“Those who can not adjust to change will be swept aside by it. Those who recognize change and react accordingly will benefit.”

Jim Rogers

What Is The Relative Strength Index?

The Relative Strength Index (RSI) is a well versed momentum based oscillator which is used to measure the speed (velocity) as well as the change (magnitude) of directional price movements. Essentially RSI, when graphed, provides a visual mean to monitor both the current, as well as historical, strength and weakness of a particular market. The strength or weakness is based on closing prices over the duration of a specified trading period creating a reliable metric of price and momentum changes. Given the popularity of cash settled instruments (stock indexes) and leveraged financial products (the entire field of derivatives); RSI has proven to be a viable indicator of price movements.

History

J.Welles Wilder Jr. is the creator of the Relative Strength Index. A former Navy mechanic, Wilder would later go on to a career as a mechanical engineer. After a few years of trading commodities, Wilder focused his efforts on the study of technical analysis. In 1978 he published New Concepts in Technical Trading Systems. This work featured the debut of his new momentum oscillator, the Relative Strength Index, better known as RSI.

Over the years, RSI has remained quite popular and is now seen as one of the core, essential tools used by technical analysts the world over. Some practitioners of RSI have gone on to further build upon the work of Wilder. One rather notable example is James Cardwell who used RSI for trend confirmation.

The Basics

As previously mentioned, RSI is a momentum based oscillator. What this means is that as an oscillator, this indicator operates within a band or a set range of numbers or parameters. Specifically, RSI operates between a scale of 0 and 100. The closer RSI is to 0, the weaker the momentum is for price movements. The opposite is also true. An RSI closer to 100 indicates a period of stronger momentum.

– 14 days is likely the most popular period, however traders have been known to use a wide variety of numbers of days.