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Technical analysis is a crucial skill for traders who seek to understand and predict market movements. Unlike fundamental analysis, which focuses on a country’s economy, currency, and broader economic factors, technical analysis involves studying historical price and volume data to identify patterns and trends. In this blog, we'll look into the fundamentals of technical analysis, explore key tools and indicators, and provide practical tips for traders looking to master this essential aspect of trading.
Understanding Technical Analysis
Technical analysis is the way to predict market movements by analyzing past price positions, volume traded and present trends the market is following by figuring out the patterns the market is making.
The reason behind its wide use is the noted observance of pattern outcomes throughout history. Huge price action takes place between buyers and sellers, which determines a certain price of a security over time.
A market moves through candlesticks in a chart and you can adjust the timeframes from a second to a year! These timeframes indicate the advancement of the market in periods that suit the trading styles of a trader.
A trader can execute his trades according to the timeframe he chooses like in minutes, hours, a day, or weeks and years. Higher timeframes track the trend direction and lower timeframes check the interest of the participants.
The market trends deeply depend on market psychology - a constant battle between buyers and sellers setting the market on chaotic price action. Market psychology plays a great role in technical analysis, as the tension between participants sets patterns and trends in the market.
We will look into some of the chart patterns that predict future trends.
Support and Resistance, Trendlines, Triangles, Flags, Wedges, Curves, Double Top, and Engulfing Candles.
Support and Resistance :
In the daily charts of any security or market, you can witness patterns obeying their supply/demand zone. The demand zone is where security is at its lowest, and that’s where investors start buying the asset. We can call it support as the security does not fall further enough and bounces back higher to simulate the supply zone. The supply zone is the area where assets get overvalued, resulting in investors selling their profits. This zone is called resistance, as the price does not break past highs and obeys the zone.
Trendlines:
Trendlines are patterns that indicate the advancement of the market. You can identify trendlines advancing in two directions called uptrend and downtrend.
The trendline, whose support is inclining with time, and which has higher highs and higher lows than the past candlesticks, indicates an uptrend.
In an uptrend, the buyers are dominating the market, while the sellers struggle to bring the price down. The trend doesn’t make a sudden, long green candlestick; rather, it respects the inclining resistance as well. In such situations, we may see 3 to 4 little red candles with green candles.
In a downtrend, the resistance and the support lines are seen declining as the sellers in the market dominate the buyers. In the volume chart, you can see a series of red volume bars rising. The downtrend creates lower lows and lower highs than the past lows and highs.
Triangles:
Triangles are part of breakout patterns, we can see three types of patterns: ascending, descending, and symmetrical.
Ascending triangle: In an ascending triangle, the highs respect the horizontal resistance while the lows create an inclining support, hinting at buyers’ growing interest in launching an uptrend.
It is important to remember that you must take an entry only when the price has satisfied its predicted trend.
Descending triangle: In a descending triangle, the lows trail on horizontal support while the highs lose momentum with time, generating a declining resistance to a point of convergence where a downtrend originates due to the strong effects of sellers in the market, dominating the buyers.
Symmetric Triangle: In a symmetric triangle, both buyers and sellers try to pull the market in their favor, which makes the up-and-down trends decay to a point of convergence right in the middle of the merging trends.
Here, the outcome of this pattern is uncertain. The market can make its way to whichever side emerges as stronger, be it buyers or sellers.
Flags: In a flag pattern, the resistance and the support lines remain parallel to each other. The distance between the lines (range) remains constant until there is a breakout, regardless of its direction.
Bullish Flag: This flag points downward, keeping the range slanting downward until the price breaks out in a sudden upward direction.
Bearish Flag: This flag points upward, keeping the range slanting higher until the price breaks out in a sudden downward direction.
Wedges: Wedge patterns are similar to flag patterns except for their parallel lines. The lines tend to close in as time progresses. The convergence leads the price to a breakout in a direction opposite to the wedge’s slope.
Rising Wedge: The rising wedge loses its green volume as time progresses, and thus we get to see a red candle surpassing the support line, creating a new trend owned by sellers.
Falling Wedge: The falling wedge loses its red volume as time progresses, and thus we get to see a green candle surpassing the resistance line as a breakout.
Double top: The pattern shows a high at a similar price twice in the chart. It creates an M-shaped pattern, which indicates a price target among buyers but not among sellers, who keep pulling down the market, making a reversal in the trend. The outcome of this pattern is a downtrend, originating from the reversal of the second high.
Double Bottom: The pattern is seen when sellers pull down the price twice toward the same level. You can notice it has a W-shaped pattern with little rises in between. This pattern is an indication of a market reversal, hence the beginning a sudden uptrend.
Top and Bottom Curve: This curve pattern hints at market reversals. The top curve looks like an inverted U-shaped pattern, which indicates a reversal of an uptrend into a down one. The bottom curve looks like a U-shaped pattern and indicates a reversal of the downtrend.
The top curve pattern can also be recognized with double-top pattern, just with more highs than two. Traders must close their trade when they identify the trend, making new lower lows with time.
Engulfing candles
The Engulfing candles can be regarded as a reversal pattern. It is a two-candle pattern where the preceding candle is completely engulfed by the following candle. The pattern can be applicable in both reversal market, whether it are bullish or bearish.
Bullish Engulfing: Bullish engulfing occurs at the bottom of a downtrend when a red candle is engulfed by a green candle, which indicates increasing buying pressures from the opposition. The green candle starts its price below the closing price of last red candle and closes at a price higher than the red candle’s opening.
Bearish Engulfing: Bearish engulfing occurs when an uptrend has reached its peak and when the buyers have lost their grip. The green candle gets engulfed by the next red candle when sellers start pulling the market toward their favor. The red candle starts its price above the green candle’s closing price and closes at price lower than the opening of the green candle.
The engulfing pattern indicate a strong reversal of the market and is only to be taken seriously when the preceding 3–4 bars are consecutively in the same trend. Always look for confirmation before taking a trade by checking the new candle that satisfies the reversal pattern outcome.
Next Phase
After knowing about these basic patterns in the trading chart, you would be able to identify breakout and reversal patterns, depending on which you can make entries or exit for better profit opportunities.
Patterns don’t always satisfy the outcome that history serves. It may happen that you will identify a bullish flag and the breakout will be in the opposite direction. You can also face fake breakouts, which may lead you to pay a heavy price for naive decisions.
To protect your money from such incidents, you can always use risk management strategies, like using a stop-loss strategy with a proper risk-reward ratio.
A Stoploss will save you from a failing pattern outcome and fake breakouts. At last, it is rather advised to follow the price action of the market and the flow of the market before commencing your trading.
