The foundation for a successful investment is its analysis. Trading in the stock market is the path where there is always the risk of losing money. Thus a good analysis is very essential to make a profit from your investments.
Speculation is the recipe for disaster in the investment field. Thus one needs to choose an appropriate analysis tool and act with discipline based on the analysis. One shall never let human emotions (fear and greed) make the trading decisions.
There are two kinds of analytical techniques: fundamental analysis and technical analysis. In this article, we focus on the second one.
Technical analysis in the stock market is used to predict future price movements based on past data (including volume and price charts). Charts are the basis for a technical analysis whose appropriate reading gives the entry and the exit signals. The main goal is to identify the buy and sell signals using the strategy.
Charts in Technical Analysis
The price and volume plotted in the form of different charts create patterns that help to identify the market trends and the momentum of the stocks. Charts are equally important in forex trading as in the capital market.
Among various types of charts used in technical analysis candlestick, bar, and line charts are the most popular and widely used charts. These charts are plotted based on the same price actions but presented in different ways.
1. Line Charts
A line chart is formed by connecting the current closing price with the previous closing prices. It is a continuous line of closing prices of specific timeframes (hours, weeks, months, or years). It is the simplest form of chart which is easy to understand and follow. Although it provides less information than the bar charts or the candlestick charts, it is best for beginners as it can be easily interpreted and the market trend is identified at a glance.
2. Bar Charts
A bar chart shows high, low, open, and closing (HLOC) prices for the specific timeframe. In the bar chart, the highs and lows for the trading period are shown by the vertical line, then the dash to the left of the vertical bar indicates the opening price and the dash to the right of the vertical bar indicates the closing price of the specified period.
The bearish and bullish sentiments for the given period can be identified by looking at the closing price (green or red). Bar charts are used to identify the market trends, support and resistance levels, and buy-sell positions. The outlook of the bar chart is less complicated than candlestick charts which makes it a favorable trading chart for intermediate traders.
3. Candlestick Charts
Similar to bar charts, candlestick charts display the high, low, open, and closing (HLOC) prices for a specific period. The body of the candlestick represents the open and closing prices and the candlestick wicks display the period’s high and low prices.
The green color in the candlestick suggests that the closing price was higher than the opening price while the red candlestick reflects on the opening price being the higher of the two. Other than green and red, analysts can use various colors as per their preference. The candlestick chart is the most popular and widely used in chart analysis.
Major Indicators Used In Technical Analysis
Now let’s have a glance at some of the major technical indicators used by successful traders.
- Moving Averages
- Moving Average Convergence and Divergence (MACD)
- Relative Strength Indicator (RSI)
- Stochastic Indicator
- Bollinger Bands
- Fibonacci Retracement
- On Balance Volume Indicator
- Price Volume Trend
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Basic Trading Strategies For Beginners
Some of the basic trading strategies for beginners:
1. Support and Resistance
Support and resistance are the levels in price charts that act as the major barrier for the price action in a certain direction.
Support is a price level in which the falling prices of an asset or downtrend are expected to pause. At the support level, the demand for securities increases with falling prices, and eventually the buyers dominate the market causing the trend reversal. A support line is considered an entry point for a new trade.
Conversely, resistance is a price level in which the rising prices of an asset (uptrend) are expected to pause. At the resistance level, the demand for the securities decreases with rising prices and eventually the sellers dominate the market causing the trend reversal. A resistance line is considered an appropriate exit point.
A breakout occurs when the stock price moves above the resistance level or below the support level. A breakout is a potential signal for the price trending in the breakout direction. Breakout with high volume gives further strength to the breakout.
A breakout above the resistance area provides an opportunity to make an early entry into the trending market. While the breakout below the support area is the signal for sale. In an uptrend, if the prices fall back below the resistance level, it is a false breakout. Conversely in a downtrend, if the prices rally back above the support line, it is a false breakout.
Crossover is easy to spot but a very powerful and successfully applied strategy. Crossover can be applied in many technical indicators but moving averages crossover is the most popular. For long-term investors when 50 days moving average crosses above 200 days moving average, forming a golden cross, it is a buy signal. On the other hand, when the 50 days moving average crosses below 200 days moving average, it indicates a long-term bearish trend, thus providing a sell signal.
Intermediate and short-term traders may even follow 20 days and 50 days crossover.
Trendlines are easy to spot in the price charts. Trendlines are an important technical tool in making effective trades. Trendlines are formed by connecting pivot highs or pivot lows of prices to show the current market trend direction. Trendlines can be used to find breakouts, support, and resistance for an asset.
There are innumerable ways to analyze the stock or any asset. Different strategies work for different traders. It is essential for every beginner to keep patience with their trading strategy using certain technical tools. Discipline shall always be maintained while using every trading strategy
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