If you are an investor or trader, then there’s no doubt you’ve heard of technical analysis and are aware that it can help get a better understanding of an asset’s trend, momentum, support and resistance levels, and other factors.
For those looking for a deeper understanding, we’ve prepared this introductory guide to technical analysis. Whether you are a complete beginner, or a seasoned veteran looking to brush up on your technical analysis skills, this guide is designed to explore the ins and outs of technical analysis and how to utilise it with PXBT, a regulated FX and CFD broker.
What is technical analysis?
Technical analysis is the historical study of price, volume, and time, and how it relates to an individual asset or group of assets. It looks closely at past performance in an attempt to predict future outcomes in Forex, Commodities, Indices, and other assets.
Technical analysis differs from fundamental analysis by focusing primarily on price data, rather than operating expenses, revenue, or economic data.
Core principles
Efficient market hypothesis implies that the market prices in all available information and activities from market participants. Technical analysis assists investors and traders with understanding the impact of such information and how it is reflected within price action.
Markets move through phases of trending price action, or a lack of a notable trend that’s often defined as sideways movement, or being range-bound. Primary trends can develop across months to years, while secondary trends take place across weeks to months. Minor trends can also appear across smaller time frames, such as hours to days, to weeks.
Markets also exhibit cyclical behaviour, where history tends to repeat itself. This cyclical behaviour is driven by mass crowd psychology. Skilled analysts can look for repeating patterns and prepare for similar outcomes as have occurred in the past.
Types of charts
Price charts display an X and Y axis, with X representing time, and Y representing price. However, not all price charts are the same and analysts can utilise different types of charts depending on their preferences or certain attributes related to each chart. Most charts include volume data for each trading session and charts can be set at different time intervals for alternative views at the same asset.
The most common type of chart is a line chart, which shows up and down price action with a simple line. While line charts are easy to interpret, they lack additional data that other chart types provide.
More advanced charts include candlestick charts or bar charts, which provide extra information by displaying data related to the open, high, low, and close of each session. Candlestick charts are especially valuable to traders, as the shape or sequence of candlesticks can form patterns that often reveal more about internal market dynamics.
Some traders also rely on less-used chart types, such as Renko, Heikin Ashi, Kagi, or Point and figure charts.
Trend direction
The first step when performing technical analysis is to establish trend direction. Uptrends are a series of higher highs and higher lows, while downtrends are a series of lower lows and lower highs. Trends can also pause and consolidate, moving sideways within a range. This is also considered a general lack of a trend.
Typically, trends can be found using diagonal trend lines connecting highs or lows to highlight if an asset is in an uptrend or a downtrend. More advanced strategies include counting waves using Elliott Wave Principle, to better understand where an asset is within its current trend.
Support and resistance
The next step after establishing trend direction is to plot out support and resistance. Support is drawn below price action, usually at a previous low that held and caused a bounce. Conversely, resistance is drawn above price action, at areas where price was rejected in the past.
Beyond standard horizontal support and resistance, support and resistance can form at psychological levels such as rounded numbers, or at Fibonacci ratios. Fibonacci ratios are mathematical ratios derived from the Fibonacci sequence and call out levels associated with mass crowd psychology.
Chart patterns
With an understanding of support and resistance, technical analysis can reveal chart patterns if confirmed by price action with a breakout. For example, a symmetrical triangle features two converging lines. Price continues to get squeezed more tightly between rising support and downward-sloping resistance.
As price moves towards the apex of the pattern, a breakout occurs to the upside or downside. Not only does this allow a trader to prepare for the potential breakout, but it provides key levels that can be used for risk management such as stop losses.
Beware, fakeouts can occur with chart patterns and one pattern can morph into another, creating confusion for traders. It is important to look for large moves through chart pattern support or resistance or moves that occur with high volume to help confirm the existence of the pattern. Common chart patterns include triangles, wedges, cups and handles, or head and shoulders.
Key technical indicators
Technical indicators are derivatives of price and volume data that when set to certain parameters, provide a visual tool that can be used to compare and contrast past price action with current price action, and potentially predict future outcomes. Technical indicators cover a wide range of usages, such as gauging momentum, trend strength, volatility, and more.
Some of the most popular technical indicators include the Relative Strength Index, Bollinger Bands, Moving Averages, MACD, and the Ichimoku. The Relative Strength Index, for example, uses price momentum to gauge an asset’s relative strength compared to recent price action.
Meanwhile, the Bollinger Bands are a complete trading system that utilise a Simple Moving Average and an upper and lower band set at two standard deviations. The idea behind the Bollinger Bands is that they call out exceptionally strong movements that could lead to a sustained trend.
Risk management
As mentioned, support and resistance, chart patterns, and even candlestick formations can assist a trader with proper risk management. In the symmetrical triangle example above, a trader can place a buy order above support to ride a breakout higher, while using the lower support line as a level to set a stop loss.
Measuring certain chart patterns can also provide a potential target, which traders can use along with stop loss level to find the risk versus reward ratio.
Using technical analysis with PXBT
PXBT is a regulated broker offering favourable trading conditions including low fees and slippage on Forex and CFDs on Indices and Commodities. The broker uses MetaTrader 5 technology, which features built-in technical analysis and risk management tools.
This all-in-one solution provides a tailored experience for traders, ensuring that there is no need to log into multiple accounts to trade and perform technical analysis. PXBT’s technical analysis tools allow traders to draw trendlines, plot support and resistance, and add a number of different technical indicators including the most popular tools outlined above.
Learn more about PXBT
Disclaimer: The information provided herein is for informational purposes only and does not constitute personal recommendation and/or investment advice. Past performance is not a reliable indicator of future results. The financial products offered by the Company are complex and come with a high risk of losing money rapidly due to leverage. These products may not be appropriate for every investor. You should carefully assess whether you understand how these leveraged products operate and whether you can tolerate the high risk of losing your money. PXBT Trading Ltd does not serve clients from Restricted Jurisdictions as listed on its website.
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