Technical analysis can be frustrating, confusing, and sometimes looks like plain nonsense. As Warren Buffet famously said, “when I turned the chart upside down and found it looked the same, I gave up”. I don’t agree entirely, I think the age-old Japanese art of chart reading has huge value, especially when combined with fundamental analysis.
Technical analysis is an important tool. It’s excellent at highlighting trends and as such identifying potential entry and exit opportunities in liquid markets. Although technical analysis is a simple concept to grasp, many beginners overload their charts with technical indicators. This results in confusion and renders analysis useless.
In this post, you’ll learn why technical analysis is one of the most useful tools available to investors and traders alike. You’ll also learn how I use the technicals to time entry and exit areas on a chart.
What Makes Technical Analysis Useful?
Technical analysis is the study of historical price and volume data. The data points are represented in graphical form, called charts…. Okay, I know you know what tech analysis is – the study of charts, squiggly lines, candles, and indicators.
Economists and pure tech analysts would have us believe in the efficient market theory. It states, all the available information about a market is represented by the price.
I don’t think this to be totally correct. Price may hover around equilibrium most of the time but frequently moves far from equilibrium.
I take a top-down approach to trading and investing. Where I find chart reading most valuable is finding entry and exit points.
Studying technicals is really a study of crowd psychology. Analyzing what market participants think, as expressed through price.
Practicing technical analysis is a skill, there’s no doubt. If you have an aptitude for it, you’ll find it intuitive, dare I say easy, and maybe even fun. Some folks just don’t get it, and that’s what makes a market.
In my experience, charting can be as complicated or as easy as you want it to be. A purist may analyze charts by looking at scores of indicators and checking chart patterns, Elliot wave, Fibonacci, etc. Decisions need to be decisive, so the charts must be easy to read.
Technical analysis is a large subject, I’ve read many books on the subject, and while many were well researched and written. Most weren’t useful to my trading journey.
Technical analysis is also known as “The Technicals” or “Chart reading” has three main inputs and all information is derived from these.
- Price – Price drives a ton of other data too, but remember they all lag price. No surprise then, price itself is the most important input.
- Volume – The number of contracts or shares traded, volume is important. I expect volume to increase at breakouts and at important support or resistance areas. Divergence of volume can also signal a change of pace.
- Time – Time might be the least important, but wow, not so fast! WD Gann has a different idea. He achieved some crazy results by squaring time and price. He designed charts using the square of nine and uses solectial angles to predict price. He also came up with a few indicators that are offered by some chart packages.
There are lots of indicators, all of which offer insight into the market.
How you trade is an expression of your personality, and that will dictate which parts of technical analysts are useful to you. As we are all different, each trader’s chart setup will differ.
A long-term investor may, for example, consult Elliott wave theory, a medium to the short-term trader may rely on candlestick patterns, volume, and indicators.
The technicals I find most useful, include:
- Candlestick charts
- Moving averages
- Trend lines
- Support and resistance areas
In the next paragraph, I’ll show you how I use them.
How I Use Technical Analysis
I found technical analysis about fifteen years ago. I must have tried every indicator before concluding that trading was impossible. When I think back, I feel stupid. But I get it now, I was on a journey, and going through those frustrating periods was all part of the education.
There’s no wrong or right indicator, but many new traders (as I did) fall into the trap of thinking more is more. More is definitely less, having a ton of indicators will conflict, and that will cause confusion, paralysis, and frustration.
A tidy workspace equals a clear thought process, and that leads to better results, no matter the task.
My charts look clean. I don’t run a ton of indicators. I run three MA’s and I pay attention to price points, trendlines, and candle shapes.
I trade forex, employ fundamental analysis, and use the technicals to find entry points. The following is a broad outline of how In trade and what technicals I use and why.
First off, you should know, before I open my computer I know which way I want to trade the market. Rightly or wrongly, I’ll have formed an opinion on the movement from economic and political data releases.
With my charts open, I’ll mark a horizontal line at the whole and half numbers around the current price action. You know, mark 120, 120.50, 121, 121.50, etc. The reason is simple: the market (people) love round numbers and you’ll often find a trading opportunity at these points.
I add moving averages. The point of moving averages is to smooth out noisy price movement and help identify both the trend of the price and offer entry/exit opportunities.
I use the Exponential Moving Average (EMA), which measures the average price movement for the previous x periods. The EMA weighs recent price movements with more importance, which improves its performance.
I squeeze a ton of value from MA’s, they’re super important to how I trade. I use them in some unconventional ways which I’ll show you later.
Trendlines, I’ll add as many relevant trend lines as I see. I extend out old trend lines as they often become relevant again in the future.
I use, as said Candlestick charts. The high, low, open, and close are all conveyed in graphic form which is easy to read. Some candles are more equal than others, I’m on the lookout for three, and one, in particular, signals a clear buy. The long tail candle.
The long tail candle signals a struggle between buyer and sellers and the long tail suggests the loser simply ran out of numbers. This often sets up a vacuum and is a launchpad for a reversal.
To summarize, my trade setup. Presuming I’m looking to go long on a currency pair. I patiently wait for the price to enter a zone that offers support from as many of my criteria as possible.
In particular, I’m looking for a price to retrace to a whole number, an MA, and a trendline. In addition, I’m looking for a long-tailed candle to form here and that signals a buying opportunity.
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