Whether you’re a beginner trader or an intermediate investor, understanding how to conduct a technical analysis of the financial markets is one of the best ways to enhance your financial journey.
Our comprehensive guide covers all aspects of this core trading tool from chart patterns, indicators and asset types to practical real-world application when trading and investing using stocks, crypto, forex and commodities.
This accessible guide also includes a comparison with fundamental analysis to help individuals gain a deeper understanding of the key benefits of technical analysis and how it fits into a wider trading and investment strategy.
What is Technical Analysis?
At its core, technical analysis takes a deep dive into the historical movements of an asset in order to predict future prices and pre-empt price movements based on past trends. It differs from fundamental analysis as it is more focused on optimising outcomes for short-term trades, whereas fundamental methods are concerned with long-term returns.
Technical Analysis vs Fundamental Analysis
There are key differences between technical analysis and fundamental analysis which ultimately focus on whether you are investing with shorter-term or longer-term goals.
Fundamental analysis can be used for both trading and investing in the longer term, using data from both past and present, as well as economic indicators and more specific factors such as company profitability to determine the intrinsic value of an asset.
Technical analysis is a trading tool that uses detailed price chart data to identify trends and patterns and pinpoint the best entry/exit points for a trade. It is designed to support short-term investment activity with analysis focused on historical price data.
Core Principles of Technical Analysis
Technical analysis is built on a framework encompassing a number of core principles - price action, volume, trends, support/resistance levels, and market psychology.
Analysis is established on a solid base of chart patterns (both bullish and bearish) to identify price actions, trends (upwards, downwards and consolidation) and trading implications using visual support tools. Consolidation trends take place when the market leans slightly sideways during an upwards or downwards trend.
Analysis then builds from a qualitative perspective using indicators such as moving averages, the Fibonacci Retracement and Bollinger Bands alongside studies of market psychology and sentiment, looking at the key influencing factors and emotional weight behind trends. Together, these give valuable context to price and market movements, to enhance the visual research and support informed trading decisions.
Identifying support and resistance levels is another key trope of technical analysis as these offer further insights into supply/demand dynamics and price patterns. These help traders to ultimately identify the best entry and exit points, as well as employ effective risk management techniques in line with market activity and personal trading goals.
Popular Chart Types and Timeframes
There are a number of common chart types that traders should become familiar with in order to effectively assess a stock relative to its past price actions.
Candlestick Charts
The candlestick chart shows key information about an asset’s price movement over consecutive days with each candlestick representing a single day’s trading. Candlestick patterns are analysed over a given time period to help traders understand the relationship between investor sentiment and pricing.
Especially popular for informing short-term trading goals, each candlestick’s shape and size visually depict the asset’s activity. This includes the open to close range, the intra-day high and low, and the direction of market movement (increase or decrease) with black or red showing that the stock closed lower for the day and green showing it closed higher.
Common bullish candlestick patterns (formed after a market downtrend) include Hammer, Inverted Hammer and Bullish Engulfing while common bearish candlestick patterns (formed after an uptrend) include Hanging Man, Shooting Star and Bearish Engulfing.
Bar Charts
Similar analysis techniques are used for bar charts where OHLC (open high low close) charts depict a stock’s price movements over time with a single vertical bar. Especially valuable when looking at longer-term price movements, each bar depicts price action for one day, one week or one month.
The highest point represents the highest price traded during the chosen period, the lowest point shows the lowest price and the horizontal bars to the left/right show the opening and closing prices. These help traders to identify trends, interpret volatility and employ effective risk management techniques.
Line Charts
Ideal for those seeking a quick and simple view of asset pricing, line charts show the direction in which an asset is moving (up, down or sideways) over a specific period using a series of data points connected with a line. While they are useful to an extent, they usually only show the closing prices of a trade. This means that the data may not fully encapsulate key context, patterns or trends. Therefore, they are often more effective when analysed in tandem with bar and candlestick charts.
Key Indicators and Tools in Technical Analysis
Technical analysis is supported by a diverse range of indicators to help traders at all levels gain insights into trends and analyse the real meaning behind the data. Traders may choose to use indicators in conjunction with one another to gain a deeper market overview and confirmation of price movements.
Moving Averages (MA)
Moving averages are used to indicate support and resistance levels, identify trends and pinpoint entry and exit points for different stocks and assets. Their most significant USP, which is especially relevant in the financial markets, is cutting out the noise of short-term volatility and price fluctuations to focus more on overarching price trends in a set period.
Moving averages are typically based on closing prices and use just one data point per day. A rising moving average indicates uptrend and falling moving average indicates a downtrend. If a moving average is flat, it suggests that the market is consolidating. Traders also commonly look out for crossovers as this can signal a shift in trend.
The Simple Moving Average (SMA) is the most widely recognised – it represents the average closing prices of the previous 14 periods (14 being an example). The Exponential Moving Average (EMA) focuses more on recent price data – while the SMA is a lagging indicator, the EMA responds more quickly to price changes.
The moving average may generate false signals and may not work so effectively in volatile markets. They are most effective when used in conjunction with other indicators to confirm trends.
Relative Strength Index (RSI)
As a momentum indicator, the RSI measures the speed and change of price fluctuations on a scale of 0 to 100. Specifically valuable for identifying overbought and oversold conditions, as well as potential trend reversals, it is calculated simply by measuring average gain divided by average loss, which is then converted to a relative strength index between 0 and 100.
More specifically, the average gain is the total price changes over the designated time period divided by the number of periods to attain the average – average loss works in the same way but with downward price changes.
The RSI has a standard setting of 14 time periods but it can be customised to different timeframes in order for traders to best understand the implications of the data.
MACD (Moving Average Convergence Divergence)
As a trend-following indicator designed to gauge momentum and crossovers, the Moving Average Convergence Divergence (MACD) is extremely accessible, making it a top choice for beginner investors. It measures the relationship between two moving averages with a visual comprised of two lines designed to identify trends and buy and sell signals, as well as bullish/bearish movement.
The MACD line depicts the difference between the 12-day exponential moving average (EMA) subtracted from the 26-day exponential moving average. The second line - the ‘signal line’ - shows the nine-day moving average of the MACD.
The central line is positioned at zero – when the MACD line crosses above the signal line, this signifies bullish trends and a good time to buy. When it crosses below, this indicates bearish trends. Any deviations between the price and the indicator may sometimes indicate trend reversal or slowdown depending on the context.
Bollinger Bands
Bollinger Bands are another popular momentum indicator, designed to help traders understand volatility and breakout potential. Bands are positioned to compare the simple moving average of a stock or asset against any noticeable divergence away from the norm in order to understand the impact of volatility and overbought/oversold conditions on market movement.
Built on the premise that prices typically revert to the mean, Bollinger Band analysis can also help traders to anticipate trend reversals and breakouts, as well as recognise when to trade or short in the direction of a breakout based on bullish/bearish activity.
Fibonacci Retracement
As a tool used to find potential support and resistance zones, Fibonacci retracement levels are rooted in the esteemed Fibonacci sequence.
It works by analysing how far a stock price needs to pull back before resuming its trend, as well as identifying key points in a trend where stocks pull back, reverse or continue on their trajectory. When utilising retracement levels, traders must first work out whether the asset is in a downward or upward trend, and then identify the points where the price is swinging high and low.
Trading platforms typically generate key retracement levels to help traders predict price movements, with shallow retracements or pullbacks indicating strong price momentum and deeper pullbacks suggestive of potential trend reversals.
These retracement levels have been specifically established in line with research into market sentiment, psychology and other data such as moving averages, and provide valuable indications to support traders in risk management, e.g. placing a stop-loss order just beyond a level. As with other technical analysis tools, they are extremely adaptable to different timeframes and assets.
Common Technical Chart Patterns Explained
Below, we have outlined some of the most common bullish and bearish chart patterns used in technical analysis, including head and shoulders, double tops/bottoms, and triangles and flags. Recognising and learning how to read patterns is essential for traders to best predict potential price movements and understand the trading implications and risk levels associated with subsequent trading decisions.
Every chart pattern can create false signals, which is why the use of a range of technical indicators can help to consolidate findings.
Head and Shoulders
This reversal (bullish to bearish) pattern is one of the most widely used chart patterns, formed with three peaks – the outer two are of similar height (the shoulders), and the middle is the highest (the head). Designed to help traders recognise when an upward trend is in its final stages, it is formed after a long bullish trend, when the stock price rises to a peak and then falls back down to the base prior to its increase.
When the price increases above the peak again to a larger level, it forms the head and then decreases back down to the original baseline. Finally, it peaks again to the level of the first “shoulder” and falls to complete the head and shoulders formation.
The neckline consists of the lines connecting the “troughs” and marks the support or resistance levels. Less commonly, traders may use an inverse head and shoulder chart pattern to predict a bearish-to-bullish trend.
Double Tops and Bottoms
Using the candlestick chart, the double tops and bottoms pattern is designed to identify major trend reversal levels and/or the price limit of a stock/asset, The double top pattern is formed after a significant high is reached, pulls back, peaks again to a similar level of the first upswing and drops back down to the low between the two peaks.
The pattern is only complete when the second low point is reached. This shows the price pushing against resistance at the peak, indicating it cannot move past this level. The two peaks do not need to reach an identical level. This pattern indicates a trend reversal.
A double bottom candlestick pattern is the same activity in reverse – when the price drops to a low, pulls back up, drops back again to the initial low and then moves back above the top swing between the lows. As with the double top pattern, the two lows do not need to be exactly equal. When complete, the double bottom pattern indicates a bullish reversal as it cannot drop any further below the support levels.
These patterns help traders to identify short and long positions as well as build risk management into their strategy.
Triangles
Formed by converging trendlines on a price chart connecting the highest lows and lowest highs, triangles are continuation chart patterns that help to identify breakout potential and predict price movements.
Applicable across a range of timeframes and commodities, there are three main types of triangle chart pattern. A symmetrical triangle pattern indicates a potential breakout in either direction, an ascending triangle pattern is a potentially bullish signal and a descending triangle pattern suggests potentially bearish activity.
Ascending triangles are represented by a flat upper trendline and a rising lower trendline, indicating rising prices and strong resistance, while the descending triangle pattern features a flat lower trendline and declining upper trendline. Traders will usually wait for a breakout above or below the upper/lower trendline to indicate the official trading signal.
Flags
The flag is another continuation chart pattern that helps traders to identify bullish or bearish signals and breakout potential. The name is derived from the pattern made by price movements, whereby a significant price movement is represented by the straight line of the flagpole while the price highs and lows experienced during the period of consolidation create the flag shape (horizontal rectangles or parallelograms).
A bullish flag pattern occurs during a market uptrend and a bearish flag pattern during a market downtrend. Patterns can be identified by looking at the peaks and troughs as well as volume during the consolidation period, the latter of which should decrease while the flag is forming, then increase during the breakout. When the price breaks out of the pattern in the direction of the flagpole, this signals the continuation of the trend.
Flag patterns are one of the most effective ways for traders to predict both the speed and magnitude of price movements and can be applied to a range of assets across different timeframes.
Applying Technical Analysis Across Markets
Technical analysis can be easily and effectively applied to trading with stocks, forex, crypto and commodities. It represents an invaluable toolkit for traders who wish to equip themselves with the most effective knowledge and methodology available to take advantage of key opportunities and make informed trading decisions.
In the financial markets where volatility is common, technical analysis offers traders a solid foundation on which to identify key entry and exit levels and recognise potential opportunities in fast-moving sectors. As a versatile concept, it can be easily adapted to fit many different styles of trading and is especially effective for short-term trading styles such as day trades, swing trading and scalping.
Not only does technical analysis work with many different types of trading style, but the financial trading landscape itself has also adjusted to accommodate sophisticated technology supporting the concept. Some of the best online trading and investment brokerage platforms come complete with platforms including advanced technical analysis software, such as mobile charting tools and automated trading functionality.
Designed to streamline and enhance the trader experience, this advanced functionality helps traders to quickly and effectively break down vast amounts of data and identify even the most complex of patterns using features such as prediction modelling and real-time visualisations. Ultimately, this gives traders a deep, holistic understanding of the price movements of their chosen assets in order to learn how to pinpoint the best opportunities.
Does Technical Analysis Work? Evaluating Its Effectiveness
Technical analysis should be a core element of every trader’s journey because it is specifically structured to optimise outcomes. With methodology encompassing a vast range of tools, indicators and chart patterns, it is effective because it works with real data, helping traders to break the numbers down accurately and efficiently to support informed decisions in real-time.
Technical analysis tools are readily accessible and adaptable across all types of trading, allowing traders to customise their usage to personal goals and maximise the benefits of the methodology. It breaks down the essential components common to every trading journey (e.g. support and resistance levels, and price trends) to help even beginner traders to make fully informed trading decisions.
Final Thoughts: Why Technical Analysis Remains a Core Tool
As one of the most powerful techniques available to traders, technical analysis has transformed the face of trading in the financial markets, making it fully accessible to those at all levels with a plethora of tried and tested techniques to translate data into decisions.
As a versatile and customisable concept, it complements broader strategies and even the most niche trading goals. Ultimately, technical analysis helps traders to understand the foundations of the markets, work with the underlying dynamics of supply and demand, analyse patterns and consistently tweak a strategic approach in line with the most reliable data.
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