Technical analysis involves identifying trends from statistical data. Traders will use this historical information to predict what will happen with the asset in the future.
It is important to understand that past performance is not always a reliable guide to how the asset will perform in the future. With this in mind, you should always use technical analysis in tandem with other trading techniques and strategies.
Choose your time period
First, establish what kind of trader you are. Do you like to buy and sell your positions at a fast pace, or are you more likely to hold on to your assets for a longer period of time?
How you answer this question will determine the type of trend you will use to conduct your analysis. There are typically three trends you can choose from – short term, intermediate term and long term.
People who like to move in and out of trading positions at a fast pace generally use daily and intraday charts for their analysis, while those who take their time are more likely to use weekly or even monthly charts.
Support and resistance levels
One way to use technical analysis is to work out support and resistance levels for your asset. These are the points at which the current trend of the market is expected to reverse. This is known as ‘support’ in a downward trend and ‘resistance’ in an upward trend.
Traders who use support and resistance levels in their analysis will anticipate that the market will ‘bounce off’ these points and continue in the opposite direction. As such, they will start to sell their asset in an upward trend or buy in a downward trend.
To make support and resistance lines more reliable, many traders will plot levels across different time periods – such as hourly or daily charts. If these levels are around the same point on each chart, then the asset is more likely to ‘bounce off’ at this position.
Sometimes a trend will break through support and resistance levels and carry on the same trajectory. If this happens, traders will look for it to continue to the next support or resistance level and react off that.
After a support level has been broken, it will usually become a resistance level if the asset you are trading starts to increase in value. The same holds true if a resistance level is broken, in that it will become a new support level if the instrument suddenly declines.
An upward or downward trend does not continue along the same trajectory all the time. Instead, you will notice that there are constant peaks and troughs throughout the entire trend line.
In an upward trend, for example, the asset will increase in value, dip slightly, and then continue moving up. Conversely, downward trends will occasionally move up before resuming the move down. This minor correction in trend is known as a retracement.
Retracements are expressed as a percentage. The most commonly-used values are 50% and 100%, with various other levels appearing in between.
A trend line is an excellent way to predict which way the market is heading. To do this, draw two diagonal lines that connect consecutive peaks and troughs.
Once the trend lines have been completed, the price of your asset will typically move between them as it continues its upward or downward trajectory. If the instrument breaks one of these lines, it signifies that the trend is over.
Trend lines that have been tested numerous times become more valuable to traders, as this means the current trajectory is likely to last longer. However, the market must touch these trend lines at least three times before they become valid. If it does not, then it is not an actual trend.
These are useful instruments to predict if a change in trend is due to happen. Oscillators will inform investors whether a particular asset has been overbought or oversold. If this happens, the market will be unable to sustain its current trajectory and will be more likely to reverse.