Technical analysis

Technical analysis is also called chart analysis. Contrary to the fundamental analysis, which is mostly based on complicated models, the technical analysis is used to attempt to create a price estimation based on previous charts. Thereby, the chart is examined for specific price patterns.

How does the technical analysis work?

The technical analysis is a broad range of indicators, oscillators, trend lines and chart patterns. The diversity of the approaches makes it difficult to completely implement everything. That is why we are concentrating on the essential approaches.

Instruments used for the technical analysis

1. Trends and trend detection

2. Trade margins

3. Support and resistance lines

4. Chart formations:

  • Flag
  • Pennant
  • Triangles
  • Wedge
  • Gaps
  • Reversal bars
  • Top- and bottom formations
  • V-tops- and V-bottoms
  • Head-shoulder formations
  • Saucer formation
  • Island reversal
  • Double tops and double bottoms

5. Indicators and oscillators:

  • Sliding averages
  • Momentum oscillator
  • Rate of change
  • Relative Strength Index (RSI)
  • Moving Average Channel
  • Moving Average Convergent Divergence (MACD)
  • Bollinger Bands

All the methods of technical analysis arose from the desire to get a certain amount of security in trading and to find concrete entry-level setups, which yield reproducible profits. The basic assumption when looking at the prices is that all information is included therein. Because no matter who may have an information advantage on the market, he still has to enter his order into the order screen, and thereby changes the prices. Even the analyst, who has a fundamental approach, will bring an order to the market sooner or later. Accordingly, the overall behaviour of all market participants can be seen in the price development. With the help of this knowledge one can now deduce actions for the entry, and set logical stops.

To find entry-level setups, the trader must ask himself the question: Who will buy or sell after me? That is the only way that profits are possible at all. For this reason, the chart analysis attempts to identify situations in the chart where it can be assumed that after entry other market participants will also enter or exit. In order to be safe, attempts are made to ride on the big investors’ coattails, who move large amounts of money. A large investor will never enter into a market in one go, since he would thereby decrease his own initial rate. Accordingly, he will enter progressively. Every time the prices are low and favourable, he will build up a part of his position. This is how trends arise, because these investors will further buy low (long) or sell high (short) in this adjustment period.

Types of graphs / charts

The various types of graphs result from the various trading approaches. Each graph has certain advantages, so that one can visualise certain details better. The bar graph is the most widely used graph.

  • Bar Graph
  • Candlestick Chart
  • Kagi Chart
  • Line Graph
  • Point und Figure Chart

Why does the technical chart analysis work?

The use of charts as an indicator of future performance of a share is a very controversial topic. The so-called Random Walkers are a group of economists who believe that the price action is purely based on coincidence – i.e. charts can thus only show the past and do not offer any conclusions about the future. The Random Walkers forget that the market rate is a result of the stock exchange listing, which is based on the aggregated activities of all market participants. For this reason, the fundamental behaviour of the participants can also be seen in a chart. A trend would not appear as clearly in a randomly generated chart as is the case with the actual market rate. The market participants produce similar price patterns based on their decisions, from which one can then derive rules for the future. That is why there are severe changes when distinctive points in the chart are exceeded or fall short. This would not happen with coincidental exchange rates.

Unfortunately, the technical approach cannot be proven mathematically since the rate patterns cannot be defined precisely. If, for example, you observe a trend, the question arises as to when this is broken and when not. If the trend is broken by a spike, for example, but then turns back in the original direction, it is broken from a mathematical point of view. A trader might use this as a signal (for example a reversal bar) to act, based on the direction of the original trend, since he knows that there is a high probability of the trade ending in a profit. Of course, as a trader, one knows that there are also random price fluctuations. This is called “random market noise”. Thereby one only has a certain probability on one’s side.

In principle, however, it can be said that human behaviour in the markets creates chart patterns, which always recur. Thus, the chart can be used well to forecast future price movements. Furthermore, charts are also well-suited for risk and money management, since the participants’ pressure for action develops on certain points on the chart. That’s why you already know beforehand where a trading idea is bust.

Who does technical chart analysis?

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