Principles of technical analysis
Key Concepts of Technical Analysis
Classification of Technical Analysis Methods.
Methods applying filtration or mathematical approximation of time series are called analytical. The main tool of this method is an indicator which is a set of features from one or more main time series.
The most popular platform for trading with indicators on Forex is MetaTrader4. It allows you to adjust the performance of indicators by certain parameters:
- color of elements
- line thickness
- sizes of signs used
You can configure the necessary parameters by right clicking on the chart and selecting “List of Indicators” in resulting menu. Next, select the desired indicator and click the “Properties” button.
Ralph Elliott suggested to use the wave analysis in 1938. According to his theory, the price movement can be represented by several waves:
- 5 waves following the main trend (waves 1-5);
- 3 waves in the opposite direction (A, B, C)
Waves can be divided into two types:
- impulse which creates the dominant trend – (1, 3, 5, A, C).
- corrective (pullback) which moves against the current trend – (2, 4, B).
According to the Elliott’s theory, any of these waves on the trading chart is a part of another longer one which can be subdivided into even shorter ones.
Usually, it is not always possible to indicate accurately the impulse waves 1, 3, 5, which consist of five other subwaves.
When analyzing the Elliott’s chart, you can pretty exactly determine the current state of the market, which will help you to make the most correct decision. The chart below shows that in the future the 3d wave will cause a small decline (4th wave), and then again will increase the growth of the current rate to the maximum value. After this, the decline will come next, before which it is necessary to lock in profits, and then close the long positions.
Resistance level is the price line from which the price increase starts. When the price falls to a given level, it starts out from it and moves in the opposite direction. Support level breakout may still happen, but not at the first attempt. Most often, after breakout the support level becomes the resistance level.
Resistance level is the limit from which the price starts to move down (opposite to the support level). Once the resistance level is broken, it is often transformed into the support level.
To display the resistance and support levels on the chart, it is necessary to allocate the largest concentration of the highs and lows of the price. However, you should take into account the sentiment of the whole market, and not just its highs and lows.
Support and resistance levels are quite powerful tools in trading despite its simplicity.
In technical analysis, there is such element as a “channel” that is some kind of a corridor between support and resistance lines. The duration of the price stay in this corridor influences whether the price leaves it or not. There are three types of channels:
- bullish – a channel with an upward trend
- bearish – a channel with a downward trend
The signal for buying is a breakout of the resistance level in the bullish channel. The reverse situation is observed in the bearish channel. There are two basic rules for traders within the channel:
- trading should be in the direction of the main trend
- the longer the price is in the channel, the higher the probability that it will leave it soon
The construction of the price channel for identifying the guiding trend is possible using inclined support and resistance lines. For this, you will need only three points, a maximum and two minimums (in case of an uptrend), or a minimum and two maximums (in case of a downtrend). Due to the fact that the maximum (minimum) indicators may depend on the news data or the long market inertia, the resistance and support lines on the chart should be drawn through the price clusters.
23.8%, 38.2%, 50% and 61.8% indicators are generally considered the Fibonacci retracement levels allowing for analysis and forecast of financial instruments dynamics
However, the key trend cannot always go up, and at some point, it pulls back.
The levels provide an opportunity to understand correctly the main objectives of correction.
The price chart shows an uptrend that met with some resistance at 0.7800. After that, the correction was fixed to approximately 61.8%, which is a consistently high support level. At this level, the breakout was able to continue correction up to 50%. However, in the current situation, the currency quotations rebounded from 61.8% and retesting of the entire level took place.
In the event that the trend continues to move in the current direction, the main targets will be 161.8%, 261.8% and 423.6% Fibonacci levels.
Summarizing the above, it should be noted that the levels allow the trader to find timely correction moments and fairly strong support and resistance levels.