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Basics FAQ of Technical Analysis

Define your Technical Analysis Framework

 

Technical Analysis –Basic FAQ for Beginners


"If Fundamentals are the Brain of the Market Technical Analysis is its Soul"

 

Technical Analysis is a method of forecasting future financial price movement based on the evaluation of past price movement and on other statistics generated by past market activity data. Technical analysis is not able to predict future price movements -but it can provide a framework for measuring the likelihood that certain price movements may occur in the future. A technical analyst uses charts, indicators and oscillators to identify patterns that can suggest future price movement. Technical analysis can be applied when trading shares, commodities, bonds, Forex currencies, or any other financial instrument where the price is determined by the market forces of supply and demand. Technical analysts focusing on two major aspects: 
1. What is the current price of a financial security 
2. What is the history of price movements of this financial security 
 


Major Assumptions of Technical Analysis


1. Full information and fundamentals are already incorporated in the current price level 
Furthermore, a technical analyst doesn't care if a stock or an index is undervalued in financial terms –he is just focusing on short-term moves that may generate trading profits on his behalf. 
2. Prices are moving in trends 
When a major trend has been established, the future price movement is more likely to follow the same direction. 
3. Price Movements Are Not Totally Random 
4. Historic trends are usually repeating in the same patterns 
This is happening because markets are traded by humans –and human psychology is based on factors that tend to repeat over time. Technical analysis uses chart patterns and indicators to analyze and evaluate these market movements and trends. 
5. There is no particular time-frame when you trade the market  
Trading the market using technical analysis may be based on multiple timeframes.

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Three important Trading Factors


Traders who are using technical analysis usually focus on short-term price movements and thus there are three important factors to be considered: 
1. Low trading cost (spreads, trading commissions, overnight rates)
2. High volume activity that may provide easy entry / exit 
3. Potential of significant short-term price volatility (volatility is important when trading derivatives)
 

Three Steps When Evaluating a Trade using Technical Analysis


Usually technical analysts employ a 3-step approach in order to evaluate their profit potential. This approach has the characteristics of an outside-in analysis. Here is this 3-step approach: 
1) Analysis of different markets around the world –Market Selection-
2) Analysis of the strongest and weakest sectors of the market –Sector Selection- {in case of trading stocks or bonds the sector selection refers to specific industries}
3) Analysis of strongest and weakest financial assets of the selected sector –Asset Selection-


PAMM 250

 


Components of a Simple Technical Analysis Framework
 

1) Identify the current trend 
In order to identify the current trend, a technical analyst usually uses mainly trendlines and moving averages. 
2) Identify Support and Resistance Price Levels 
A break below a support level is considered a bearish sign. A break above a Resistance level is considered a bullish sign. 
3) Identify Momentum 
Momentum is usually measured by technical analysts using MACD. If MACD is above its 9-day Moving Average then the momentum is considered bullish. 
4) Identify Significant Changes in Volume or Price Volatility
Abnormal changes in the volume or price volatility may trigger or give an end to a current trend. Technical analysts always keep an eye on volume activity via historic data and trace significant changes. 

  

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