Technical Analysis of financial markets is the study of market action using price charts to forecast future price direction. The basic philosophy of technical analysts is that all factors that influence price are quickly reflected in the price and the study of price action can reveal future performance. Technicians are concerned with the trends implied by past data, charts and technical indicators. Many believe that history repeats itself in the markets. A fundamental analyst on the other hand tries to ascertain the intrinsic value of a security in an effort to forecast future performance.
As Charles Dow, a pioneer of technical analysis in the late 1800’s said, “the market reduces to a bloodless verdict all knowledge bearing on finance, both domestic and foreign.” Other famous pioneers in the early half of the 20th century include W.D. Gann and R.N. Elliott. Over the decades and particularly with the dawn of the computer age, technical analysis has grown in sophistication and popularity and is widely practised in the analysis of markets today. In fact most online brokers and trading platforms offer free charting packages.
Technical analysis is used to identify trade entry levels as well as targets for taking a profit or a loss. There are many indicators used in technical analyis and reading a book on the topic is likely to leave one more confused than ever. The main point is that you don't need to know every indicator in order to trade successfully. In fact, a major pitfall for those starting out in trading is using too many technical analysis indicators in their analysis, thereby over-complicating the trading process. Most traders only use a handful of indicators in order to trade. However, it is good to know that other technical analysis indicators exist and that there are traders out there who have a different view to what your analysis suggests.
Below is a list of popular indicators with further explanations on the links. It is an explanatory section rather than a comment on the effectiveness of the indicator. It is not necessary to learn how to apply them all and again I stress that most traders only use a few in their trading.
It is important to know the trend in the market. The trend refers to the overall direction in which the market is moving. Trend technical analysis indicators help to identify this movement. Essentially the market has three different modes, an upward trend, a downward trend and a sideways trend. If you can identify the trend then you can adapt your strategy to take advantage of it. However, the time frame of your trading strategy is also important. For example, the trend of a financial security may be down on a monthly chart but up on an intra-day chart. A long term investor, therefore, may be selling while a day trader may be buying because they are following the trend relevant to their time frame. The indicator may also differ depending on the types of charts employed.
Volatility in financial markets is a measure of the price variation of a market over time. Volatility technical analysis indicators show the size and the magnitude of the price fluctuations of a financial instrument. Markets change from periods of high volatility (wide fluctuations in prices) to low volatility (a reduction in fluctuations in prices). Typically, markets become more volatile in an environment of fear or panic. Knowledge of the historical volatility of a market can aid trading strategy because it gives the trader a better idea of how prices much prices will fluctuate during times of high and low volatility.
Momentum indicators can help ascertain the strength of a markets movement. Markets may move upwards or downwards but lack momentum or strength in doing so. This could signify a lack of conviction in the move. Momentum indicators show the strength of trends by recording the speed of price movement over a given time period. For example, the beginning of a trend will typically display strong momentum but that momentum will weaken as the trend comes to an end. Momentum indicators are often displayed as an oscillator. An oscillator is an indicator that fluctuates above and below a centreline. It normally has an upper and lower band which indicates overbought and oversold conditions in the market.
Volume is the number of shares or contracts traded in a financial market. Volume indicators are often used to confirm the strength of trends. Volume can be an important indicator at major turning points in the market. The start of a new trend can be accompanied by a large increase in volume as traders and investors initiate new positions or liquidate existing positions. A decrease in volume can signify the end of a trend as the market loses momentum and traders lose interest or certainty. Lack of confirmation may warn of a reversal. These indicators are used to determine investors' interest in the market. Listed below are some popular indicators.