Why technical analysis is popular among traders. Its basics and methods read in this article
Technical analysis is a universal technique for predicting the price movement of any exchange-traded financial asset (currency pairs, stocks, futures, options, and cryptocurrencies). It is positioned as an alternative to the fundamental, which opens deals on economic and political events, rumors, and moods of the market crowd. Technical analysis works only with mathematical algorithms for processing historical price data.
The basic principles were published by Charles Dow in the Wall Street Journal in 1900-1902. The basis was the study of stock market statistics, this theory works well in the Forex currency market. The analysis works on three principles:
Example: Euro/Dollar chart shows the price max/min for the week and month.
See how price pulls back from these strong price levels. You can open profitable trades both to buy (BUY) and sell (SELL). Dow's theory is confirmed: everything repeats itself, people think stereotypically. Only market makers and external economic events can change the situation. This shows a breakdown of the monthly high with an uptrend development. It is not recommended to determine decisions only by levels; we are always looking for confirmation from indicators or patterns of graphical analysis!
Recommendation for traders: When trading on historical levels, see how they are located. If the opening level of a new Forex session is about strong max/min, wait for how the situation will develop in the European session. Or open only with short-term deals.
Example: "сlassical" method of determining the "real" trend for several price trends. Known as the "Three Elder Screens" strategy.
The idea is to simultaneously analyze the price movement on three timeframes from the lowest to the highest. An example would be the Australian dollar and the M1-M5-M15 timeframes. This is a combination for short-term transactions. For intraday and medium-term ones, you need to increase the time, you can M30-H1-H4, the principle of the strategy does not change.
So. First, we look at the "longest" timeframe, we have it M15. Then it goes “down” and if the price movement coincides on all three, you can open a deal in the direction of the global trend. It is recommended to add an overbought/oversold oscillator for confirmation. We have this Stochastic, which indicates a reversal and the beginning of an uptrend. The strategy works well on timeframes from M30 and also confirms the Dow Theory and technical analysis in general.
Recommendation for traders: in addition to the indicators, look at the graphical patterns. They can cancel the signal, especially if they are on higher timeframes.
The Dow Theory states that at any moment in time a directional movement can be determined on a trading asset. But, observations of the real market show that most of the time (up to 70%), the price moves, albeit in a wide, but still sideways range. At the same time, the possibility of medium- and long-term forecasting based on historical data remains.
In addition to the basic ones, the technique has two additional rules:
Variants of technical analysis methods
Technical strategies are divided into two groups: graphical and mathematical. Special lines are drawn on the price chart:
Example: British pound. A currency pair with good volatility in the European session and during the Europe / America overlap.
It gives good trend channels with a width of 20-30 points, as in the example. This allows you to open profitable trades on pullbacks from trend lines or support/resistance levels. Even without additional confirmation, although beginners do not need to do this. It is also recommended to check the levels for historical max/min, especially if these are intraday transactions.
The pound has always been a difficult, although profitable pair. The levels may not work, especially on a rollback. Fundamental news after Brexit may also not give a strong reaction. But, in general, pound trends last long enough and reversals can be identified by additional indicators. If the “width” of the trend channel is less than 20 points, you need to switch to trend strategies; trades on pullbacks will be risky even with good money management!
Recommendation for traders: the practice has shown, we trade no more than 2-3 retests of trend lines or support/resistance levels. Next, there is a high possibility of a trend reversal!
Mathematical methods are based on the mathematical processing of past data, which corresponds to the principle of "price takes everything into account". Technical analysis indicators show the dynamics of price changes more clearly: trend indicators, where the market is going, oscillators, how this movement occurs.
Technical analysis uses several options for the price chart; the trader can choose the most convenient for himself and the trading strategy:
Example: a line chart is used to determine the overall market trend, in our case intraday. We use the candlestick for “lesser” analysis and opening deals.
It is logical to ask “why to use a line chart at all because the candlestick shows the same trend and price change”. Yes, you can use only one type of chart and trade profitably. Every trader has his own opinion, this is correct. But, in our opinion, sometimes the candlestick chart prevents you from seeing the "right" trend. Several up/down candles can give a false signal of a trend change, and this is only an impulse or a local pullback. The trader may be at a loss. Professionals recommend switching to a line chart after 2-3 consecutive losing trades in order to calm down and start analyzing the market again.
Also, according to the line chart, you can see movement without "noise" for 2-3 hours ahead and open not one deal, which can be at a reversal with a loss, but several profitable ones, as shown in the image. With good money management, you can get more profit!
Recommendation for traders: the line chart is optimal for timeframes from H4. So you will see how the market is going in the future. Use candlesticks on such timeframes only to search for reversal signals.
In addition to the main ones listed above, there are also non-standard charts that take into account only the price: "tic-tac-toe", Renko and Kagi. There are reviews about their effective use in the literature, on websites, and on forums. They are not included in the basic set of indicators of trading terminals; they are available only in the form of additional indicators. Strategies based on them have not been widely adopted outside the South Asian region.
Trading strategies and non-standard analysis
To open deals, combinations of indicators are used that give trading signals according to the mathematical algorithm embedded in them. At the same time, you should always follow the basic rule of classical technical analysis: the strategy should not use only one tool for making a decision, but confirm it with others. Indicators belonging to different groups:
It is seen that the basic principles of the Dow Theory work well, make it possible, on their basis, to create their complex methods available to both professionals and beginners. Two methods can be distinguished separately:
Eliot was able to show on most exchange-traded assets (currencies too) that there is always a global market cycle of eight "waves": five of which will be the main ones, the rest are corrective ones. Also, the market has its wave pattern at each time interval and, as the cycle develops, it sets ratios according to the Fibonacci number series;
In addition to lines, strategies can use "Fan", "Spiral", "Arcs" and Fibonacci time zones. The tools are included in the basic set of all popular trading terminals, for example, MetaTrader.
Example: Fibonacci retracement levels work well on-trend reversals on any Forex currency pairs.
The main condition for profit is to correctly find the beginning and end of the previous trend. The example shows a clear reversal, which is confirmed by the overbought/oversold RSI oscillator. We trade by Fibonacci retrenchment levels, but there are also “continuation” levels that determine the strength of the trend. The first BUY trade was opened on them, which went into profit before the start of the reversal. Then, correction levels were built at which SELL transactions were opened until the moment of consolidation when the price began to move between the extreme levels. Fibonacci can and should be used as an indicator of sideways movement (flat). They should be mandatory in automatic advisors working according to the "grid" algorithm - opening several pending orders above/below the current price.
We look at how the levels are located near the historical max/min. They can both confirm and cancel the rollback/breakout.
Recommendation for traders: it is better to use Fibonacci on the main (major) currency pairs. There is sufficient liquidity there to work out the levels correctly.
There is some truth in these objections, but at the same time gaps confirm the Dow Theory - a return to previous values after the opening of a new trading day once again confirms that the price takes into account everything and is confirmed by market volumes.
In most cases, gaps are closed towards the “empty” price zone, which allows you to open a profitable trade even when there is no strong and correct signal according to the indicators (the same situation is with the release of strong news when all classical technical strategies stop working correctly).
Example: Again the Euro/Dollar. We open deals using the trend indicator and the dynamics of tick volumes.
Let's say right away that the Forex market does not provide information about transactions "in the money". This can be seen only on stock exchanges; here a trader can only see the number of deals (tick volumes) for his broker on the selected timeframe. Gaps on Forex are rare, but you can trade by volume, the main thing is to choose the most volatile periods.
Let's look at an example. In the first sale transaction, the volume indicator shows a leading signal for a reversal. The volumes grow sharply, after that the lagging trend indicator shows the beginning of a reversal. It is important to understand here – the volume indicator does not give a trend change signal, like oscillators. It gives information only about the growth of buyers/sellers ' activity and the trader should be ready to open a deal after additional confirmation. Or close the deal if the trend turns against it.
The second buy trade is also a good example of volume trading. They raise, then decline this can be seen from the price that makes the pullback. Market makers are fixing profit/loss or want to continue the downtrend. Then they start buying and a new uptrend begins.
Recommendation for traders: before opening, look at tick volumes for other brokers. There are enough statistics on the Internet that are freely available. If the general tendency to BUY/SELL is the same, it is possible and should be done.
Recommendations about use …
Example: The speed of trends is visible on Asian currencies, especially on the yen.
Moreover, a high rate of decline is observed throughout the entire Forex trading day. In the European session, “fast” downtrends are observed more often and traders are better off looking for entry points to sell. In the American and Asian sessions, the uptrends are longer and you can set large pending profit levels. In general, the trend of longer uptrends is observed on all Forex currency pairs, but only in the medium and long term. Inside the day and on scalping, the market "noise" is greater, and any trends may end after the next 2-3 price bars or candles.
We are always looking for additional confirmation. For example, this is the MACD oscillator. A break above/below the zero levels confirms a market reversal.
Recommendation for traders: the" speed " of trends is a relative concept. But, the downtrends continue to be fast. If you prefer to work in SELL, set the profit level and the transaction volume less than for BUY.
To summarize, let us once again remind you about the work of technical analysis only with historical data, there are no other options. They have not yet learned to predict the future. This means that any technical indicator and strategy work with a delay relative to the current market, a signal may appear when the optimal entry point has already passed. Therefore, never neglect visual constructions; they are in many cases much more accurate than oscillators and automatic expert advisors.