July 25

What Is Technical Analysis? (Patterns, Types of Charts, Indicators and Guide)

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Last Updated on 25 July, 2022 by Samuelsson

Whether you trace the origin to the 19th century American Charles Dow, who created the DJIA Index, or the 18th century Japanese Homma Munehisa, who invented the candlestick chart, technical analysis has got a rich history. And traders will continue to use it in their quest to get an edge in the market.

Technical analysis is an analysis method where traders analyze recurrent patterns in the price of a security, in order to know when to enter and exit the markets. Technical analysis covers a broad spectrum of methods, including commonly known methods like technical trading indicators, like the RSI and ADX, and chart patterns, like wedges and triangles. 

Technical analysts use technical analysis to track human psychology in the market and how it affects the price of a security. Owing to the importance of technical analysis in trading, we have created this comprehensive guide to teach you all you need to know about the subject.

In this guide, you will learn the following:

  • What technical analysis is, how it is used, the common criticisms, and why it works
  • How technical analysis is different from fundamental analysis
  • Price action trading
  • Indicator trading
  • Leading and lagging indicators
  • Commontypes of charts in technical analysisof
  • Seasonality in the market and how to take advantage of it
  • Common technical trading strategies
  • How to use volume in trading
  • How to make use of the volatility index in trading
  • Technical analysis tips

Since the guide is so long, we have made it easy for you to jump to your preferred sections within the article. Just click the toggle bar that exists under every major heading. Like the one below:

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And here comes the table of Contents:

What Is Technical Analysis?

Technical analysis is a method of analyzing a financial asset, such as a stock, commodity, currency pair, options, or futures, to identify trading opportunities. It is used to predict where the price of an asset will go in the future, based on what is happening in the market now and what has happened in the past. Followers of this method use various charts and market data to study the activities of investors in the market in order to forecast future price movements.

Simply put, technical analysis is a way of analyzing a market by using charts to study market action. The term market action implies all the metrics used to indicate the activity in the market, such as price, volume, and open interest. Open interest is used in the options and futures market to denote the total number of outstanding contracts that are yet to be settled.

Technical analysis is based on the idea that all you need to analyze a security — and make a fairly accurate prediction of the future price of that security — is the historical trading activity in that security, expressed in price, volume, and open interest (where applicable).

Any security that has historical market data can be analyzed with technical analysis methods. So technical analysis can be used on stocks, exchange-traded funds, bonds, currencies, futures, options, commodities, and even the volatility index.

The Importance of Price Action for Technical Traders

Unlike a fundamental analyst, who tries to evaluate a security’s intrinsic value, a typical technical trader would only study the chart to identify price patterns and changes in volume. Technical analysts believe that the price of the security and the volume transacted are the most reliable predictors of future price direction. They believe that the price and volume data can show the imbalance in supply and demand of the security, which is what determines the direction of price movement in the future.

Some technical traders (pure technical traders) make their trading decisions solely on their analysis of chart patterns and volume, without any consideration of fundamental factors. However, many technical traders still consider fundamental factors when buying or selling a security — at the very least, they stay away from the market during major news releases.

The official group that trains and certify technical analysts is the Market Technicians Association (MTA). Although any trader can learn technical analysis on his own, advanced technical analysts are examined and awarded with the Chartered Market Technicians (CMT) certification by the MTA.

Brief History of Technical Analysis

In the Western world, it is believed that technical analysis was first introduced by Charles Dow when he teamed up with his friend in 1896 to create the equity market index named after their names — Dow Jones Industrial Average. Through his regular stock market editorials in The Wall Street Journal (a financial publication he founded), Charles Dow also laid the early foundation of what later became known as the Dow Theory — the basis of technical analysis.

However, many aspects of technical analysis have been in existence in Japan more than a century before Charles Dow was born. The Japanese believe that Homma Munehisa invented technical analysis when he developed a method to track the price of rice coupons in the 18th century — what would later become known as the candlestick chart.

Read more about the history of technical analysis here.

Uses of Technical Analysis

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Technical traders have different ways of using technical analysis, and no two traders have the same approach to technical analysis, even the certified ones. So both the analysis and how it is used are quite subjective, as individuals try to modify several aspects to suit their perceptions and personalities.

However, despite the variations in methods and styles, there are some common grounds. Certain things are generally accepted, although individual traders may use different technical tools to achieve them. For the most part, technical traders use technical analysis to:

  • Identify the price trend
  • Mark important price levels
  • Know when to enter a trade
  • Estimate profit targets
  • Place stop losses
  • Decide when to exit a trade

Price Trend

Technical analysis can be used to identify, firstly, if the price is in a trend or just moving sideways. And if in a trend, it can show the direction. To know if the price is in a trend or not, traders check their price charts to see if the highs and lows of price swings remain at the same level or are moving in a particular direction.

If the price swings are moving up, with higher highs and lower lows, the price is said to be in an uptrend. Conversely, if the swings are moving lower, with lower lows and lower highs, the price is in a downtrend. Technical traders would often attach a trendline on the successive swing highs or swing lows to help them easily identify the direction through the slope of the trendline.

Alternatively, some traders use technical indicators to decipher the trend direction. The most common indicator for this purpose is the moving average indicator. A flat moving average line indicates sideways movement. If the line is sloping upwards, the price is in an upward trend, and if it’s sloping downwards, the price is trending downwards.

Trend in Technical Analysis
Trend in Technical Analysis