An Introduction to Technical Analysis
What is Technical Analysis and Does it Work?
Charts
Charts provide a graphic representation of the history of price movements and other trading data and form the basis for all decisions made by technical analysis.
The most basic chart is the bar chart. A bar chart consists of vertical lines (bars). Each bar represents a certain trading period, eg minute, day, week..., and each has a shorter horizontal line extending to the left and right. The bottom of each bar represents the lowest price reached in the period concerned. The top represents the highest price. The horizontal lines to the left and right represent the opening and closing prices respectively.
A very popular relative of the bar chart is the Japanese candlestick chart which originated from Japanese rice trader Munehisa Honma in the 17th century. Like bar charts, candlesticks consist of vertical lines the top and bottom of which represent the period's high and low respectively. In the middle of the vertical line is a rectangle (the body), running between the opening and closing price. If the closing price was higher than the opening (ie a bull market) the body is empty. If it closed lower the body is filled. Numerous patterns have been identified with colorful names such as hammer, spinning top white, and gravestone doji, to name but a few. Much has been written on candlestick charting.
Japanese Candlestick Charting Techniques
by Steve Nison. Nison's classic provides an in-depth explanation of candlestick plotting and analysis, conveying to the reader, in easy-to-understand language, the author’s years of practical experience in this increasingly popular and dynamic approach to market analysis. It includes hundreds of examples that span the equity, futures, fixed-income, and foreign exchange markets and shows how candlestick charting techniques can be used in almost any market.
Beyond Candlesticks: New Japanese Charting Techniques Revealed Steve Nison. From the "Father of Candlesticks"—penetrating new Japanese techniques for forecasting and tracking market prices and improving market timing Steve Nison has done it again. The man who revolutionized technical analysis by introducing Japanese candlestick charting techniques to Western traders is back—this time with a quartet of powerful Japanese techniques never before published or used in the West. Stunningly effective on their own, these new techniques pack an even greater wallop when teamed up with traditional trading, investing, or hedging strategies, and Steve Nison shows you how to do it.
A variation on the theme is the point and figure chart. It differs from bar and candlestick charts because it is not concerned with time.
Point and figure charts consist of a series of columns of X's and 0's. X's indicate a rising price, 0's indicate falls. The technician must determine the box size, this is the amount the price must move in order to draw a new X or 0 in the same column (ie a continuing trend). The aim is to set this large enough to filter noise, but small enough to capture essential detail. The technician must also set a reversal amount. This is the amount the price must reverse in order to draw the opposite symbol in a new column. This can be any value, but is often set to three times the box size.
Trends
"The trend is your friend", is the mantra of technical analysis. Prices tend to move in trends, and once a trend is established it continues until something happens to break it. Markets are subject to several trends at one time of varying durations from minutes, days, weeks, months, years. Each trend may experience one or more corrections when price moves temporarily in the opposite direction without the trend being broken.
Trend lines may be identified from and added to charts. In a rising trend the trend line joins the chart bottoms. In a falling trend the trend lines joins the tops.
Resistance and Support
A resistance level is a level at which an increasing price ceases increasing and starts to decrease, ie it is the price at which investors start to sell in volume, ie it is the absolute maximum the market considers the investment is worth.
A support level is a level at which a decreasing price ceases decreasing and starts to increase, ie it is the price at which investors start to buy in volume, ie it is the absolute minimum the market considers the investment is worth.
Once broken resistance and support levels often change roles, ie what was a resistance level becomes a support level and vice versa.
Recommended Reading
Stikky Stock Charts Laurence Holt. Learn the eight major chart patterns used by professionals and how to interpret them.