December 5, 2024
Technical Analysis: Brief Beginner’s Guide
When it comes to trading, you can use a set of tools or indicators to understand the market before placing an order. You may want to find how if the market is trending or ranging, and the likely direction of the value of your investment. While most investors rely on fundamentals, such as industry trends and valuation, technical analysis is a key indicator in predicting price movements based on historical data.
What is Technical Analysis?
The easiest way to define technical analysis is that it is a tool, indicator, or method used in predicting the likely future price movement of an investment asset (stock or currency pair) based on available market data. The method is based on the assumption that collective actions of buying and selling of the participants in the market can be used to assign a fair market value of the asset. In other words, the price of a financial asset or security reflects all the available information about that asset.
How to Perform Technical Analysis
Technical analysis can be summarized in four key steps:
- Identify the Trend: Trading strategies can either go with or against the trend. Before making any decision, identify whether the current price trend is upward, downward, or sideways. A trade will normally take long positions (buy) in an upward trend and take short positions (sell) in a downward trend.
- Draw the Support and Resistance Levels: These are the levels at which the price of the asset is likely to reverse or breakout. A resistance level is where the upward price moment of the security weakens causing the price to likely reverse or head downward. On the contrary, the support level is where the downward trend of a price is likely to reverse.
- Establish Entry and Exit Points: Your entry and exit position are defined by more than just the support and resistance levels. Traders usually use volatility indicators such as the Relative Strength Index (RSI) and Average True Range (ATR) to establish whether the moment behind the price movement is adequate.
- Size Your Position and Manage the Risk: Position sizing and risk management are critical to technical analysis. Choose a clear risk: reward ratio such as 1:3, and use the ATR to determine where to place your stop loss from your entry position.
How Technical Analysis Differs from Fundamental Analysis
While the two analyses are made to understand the market and make predictions, they are different in approach. On one hand, technical analysis forecasts the price movement using candlestick chart patterns. The method is effective for short- and medium-term trading. On the other hand, the fundamental analysis includes going through various economic data, central bank updates, and news to anticipate future price movements. This makes it an ideal approach for medium to long-term traditional decisions.