Technical Analysis for Beginners

Technical Analysis for Beginners
.02 Apr 2024
author avatar image Andreas Thalassinos
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Table of Contents

Introduction

This will be a lot of fun as we discuss technical analysis for beginners. This is my favourite trading approach when it comes to the financial markets. (You probably know this by now!) I devoted a few years of my life to mastering this approach, and I find it highly fascinating as it combines science and art! Yes, this is how I like to view technical analysis: science because of all these statistical tools known as oscillators and indicators, and art because of the chart patterns.

But what is Technical Analysis?

Technical Analysis is the study of price charts to forecast future price trends. It is based on three principles:

Market action discounts everything

  • All information available to the market is reflected in the price.
  • Charts reflect the psychology of the traders/investors. If the market is rising, then the psychology is bullish. On the other hand, if the market is falling, then the psychology is bearish.

History repeats itself

  • Markets move in identifiable patterns. If a price pattern has worked well, it will continue to perform well.
  • Markets are based on human crowd psychology, which never changes. It is based on fear and greed.
  • The future lies in the study of the past.

Prices move in Trends

  • In the late 19th century, Charles Dow claimed through empirical observation that prices move in trends.
  • They follow a pattern of zigzag patterns.
  • A trend is more likely to continue than to reverse.

Types of Price Charts

There are different chart types:

Bars

A vertical line bar represents the timeframe’s range (i.e. daily).

  • The tic to the left represents the Opening price.
  • The tic to the right represents the Closing price.
  • The highest point of the bar represents the High price.
  • The lowest point of the bar represents the Low price
Line bar

Japanese Candlesticks

  • The Japanese version of bar charting.
  • It records Open, High, Close, and Low prices.
  • The shadow/wick (a thin line) shows the period’s range from the high to the low.
  • The real body measures the distance between the Open and the Close.
Japanese candlestick indicating the open, close, high and low prices.

Line Chart

  • Some traders believe that closing prices are the most important factor.
  • Open, High, and Low prices are not used.
  • Shows a general picture of the price movement.
Line chart in uptrend.

Point And Figure

Alternating columns of X’s and O’s.

  • A rising column of X’s represents rising prices.
  • A falling column of O’s represents falling prices.
  • Precise signals
  • Objective trendlines
  • Price targets
  • Time is not linear
Point and Figure chart.

Advantages Of Technical Analysis

I’m sure you have started appreciating Technical Analysis’s strengths in trading in the financial markets. Well, I don’t blame you, as it has many advantages! Let’s go through them.

Timing

Timing is one of them. For starters, there are two phases to enter the market, either with a buy or sell order. The first step is the analysis, and the second is placing the order. Of course, before pulling the trigger, one has to analyze the price chart and the underlying financial instrument by their favourite approach, fundamentals, or technical. Then, enter the market with the corresponding order. The order timing is crucial as most traders prefer lower timeframes and intraday trading. Leveraged instruments boast, on the one hand, more enormous profits, but at the same time, they run the risk of more considerable losses. So, timing is essential, as a slight price movement in the opposite direction may result in losses.

On the other hand, the analysis phase may be correct; the forecasted direction is right, but eventually, they lose money due to timing just because the entry was delayed. Technical analysis is the only approach that can provide the timing factor for entering or exiting the market. Remember that all analysis methods aim to identify the market’s direction, but timing belongs to Technical Analysis. For example, the timing in a Head and Shoulders chart pattern when the price breaks below the neckline will determine a specific sell order into the market.

Flexibility To Follow Any Market Any Financial Instrument

It’s not a secret that many market analysts specialize and follow just a few assets, whereas technical analysts may follow any market or financial instrument. A head-and-shoulders pattern looks the same for both the forex and the stock market. There is no need to crunch mega numbers and figures to forecast the market’s direction.

Say that EURUSD is trapped in a narrow sideways direction, not leaving any room for potential profits, so you decide to pull the S&P500 chart instead, which is trending, identify a series of higher tops and higher bottoms for an uptrend and lower bottoms for a downtrend. If you spot equal tops and bottoms, you are probably in a sideways market. This may be applied to any price chart. After all, what we do is decipher the crowd’s psychology.

Market Rotation

Similar to the above is technical analysis’s freedom or better flexibility to rotate markets and market sectors. Say, that a specific market sector suffers from very low volatility, that is, candlesticks are very small without any hints of the direction to follow. Do you still want to trade this market? I guess not. So, choose another market or sector that looks more promising.


How do you do that? Technical analysis provides many tools to do that, which will be another guide’s topic. For starters, choose a trending market, find a sector under it that is also trending or about to reverse, and then choose the instrument that signals an impending reversal. Nevertheless, technical analysis makes choosing and rotating markets and sectors easy and fast. No need for time-consuming number crunching, after all, timing is imperative.

Timeframe

It is almost a rule that students ask me which is the best timeframe during my seminars. Well, this brings us to another significant advantage of technical analysis as it applies to any timeframe any financial instrument. Rumour has it that it is best used on lower timeframes. This, of course, is not valid. Just glancing at different charts will convince you that technical analysis applies equally healthily to lower and longer timeframes. Technical analysis in action/identification of trend through oscillators

S&P 500 uptrend chart.

Now that we understand how to identify the trend through the price action and, more precisely, with a series of successively higher tops and higher bottoms for an uptrend and a series of successively lower tops and lower bottoms for a downtrend, let’s explore a second way, the oscillators. This time I have applied one of the most popular oscillators on the price chart of S&P500. In the blink of an eye, MACD is moving into the positive area above the zero lines, signaling an upward direction. Again, easy and fast. Let’s move on to a more interesting example, the GBPUSD.

GBPUSD price chart in 30 minutes timeframe depicting downtrend.

Even though the market’s direction may not be that visible to a beginner, I am sure you will agree that the MACD started moving in the negative area below the zero lines, signaling a reversal to the downside.
This is the very early stage of a new trend.

Technical Analysis In Action – Trend Identification Through Price Action

Throughout my career, I have had many discussions with traders, both beginners and professionals, regarding the advantages of technical analysis. Rather than engaging in lengthy discussions and sometimes arguments, I prefer to present a price chart and let it do the talking. After all, a picture is worth a thousand words! What do you think is the direction of the S&P500 in the daily timeframe?

US500 daily timeframe showing uptrend.

Did you say upwards? Then I agree with you. Not that hard after all! Of course, the rationale for identifying this uptrend is behind the higher tops and bottoms sequence. Technical analysis is at the speed of light, as I usually call it. Now, let’s look at the EURUSD in the weekly timeframe.

EURUSD price chart in weekly timeframe showing downtrend.

I am sure you will agree with me that this is a downtrend. However, for non-believers, let me present the following chart, which identifies a series of lower tops and bottoms.

EURUSD weekly price chart showing a series of consecutive lower tops and bottoms in a downtrend.

A textbook downtrend at its best.

Technical Analysis Identification Through A Reversal Chart Pattern

According to the bibliography, one of the most reliable reversal patterns in technical analysis is the Head and Shoulders. It is based purely on price action, and this is where its reliability stems from. But let’s go ahead and apply it to a price chart so we can witness its value.

AUDUSD at the top of an uptrend showing a head and shoulders reversal.

The formation of a heads-and-shoulders reversal at the top of the uptrend on the AUDUSD daily timeframe signaled the end of the upward trend and the early beginning of a new trend in the opposite direction. To be more precise, that was signaled when prices successfully violated the corresponding neckline. I hope this is clear—one more example.

Gold daily price chart showing a double bottom reversal.

This time on Gold on the Daily timeframe. After a price decline, a double bottom on the price chart and the breach of the current top-level signal the beginning of a new trend toward the upside.

Criticism of Technical Analysis

It would not be fair if we didn’t mention, discuss, and address some of the criticisms of technical analysis. These usually stem from economists and fundamental analysts in general. So, before we draw any conclusions, let’s look at both sides. There are three significant criticisms, namely:

  • The self-fulfilling prophecy
  • Can the past be used to predict the future and
  • Random walk theory

Self-fulfilling Prophecy

The self-fulfilling prophecy is one of the most well-known criticisms of technical analysis. In a nutshell, they say that technical analysis works! Well, let me explain.
They claim that all technical analysts simultaneously identify the same chart patterns and enter the market. Perhaps we all know and can identify most chart patterns, but what about the timeframe? Do we also use the same timeframe? I don’t think so.

Different traders use different timeframes, and this is a fact. Some use the 5-minute, others the 1-hour, and perhaps others the daily timeframe, to name a few. Once again, different timeframes display different directions and different chart patterns. One timeframe may be pointing upwards, another downwards, whereas other ranges. The choice is up to you!

Can The Past Predict The Future?

One of the principles of technical analysis is that History repeats itself. Believe it or not, the critics doubt that past data may be used to predict the future. Yes, you heard that right. It’s like saying that statistics should not rely on data or observations from the past. By the way, how do fundamentalists or traders of the economic approach base their forecasts? Did you say the past?

Additionally, specific models that worked well in the past are used today to predict the future. That includes not only technical analysis but also economic and fundamental analysis. If the Head and Shoulders reversal pattern worked well in the past, would you use it in your trading approach? This is what we call track record, after all. The comments are yours.

Random Walk Theory

The last criticism is known as the Random Walk Theory. This is very easy. They claim that prices are serially independent and are random meaning unpredictable. Yes, unpredictable. Can you believe that? Moreover, they employ the efficient market hypothesis, which states that prices fluctuate up and down the intrinsic value in a random and unpredictable manner, and the best trading strategy to use is the “buy and hold”.


In simple words, they suggest by randomness and unpredictability that there are no trends in the market. The best answer here is to pull up any price chart and identify the trend. With just a little knowledge, anyone can determine the presence of the trend. Remember, before you invest in the markets, invest in yourself.

Conclusion

Knowledge is imperative when trading the financial markets. A thorough understanding of the financial markets is vital for any trader. The technical analysis approach allows traders to detect and interpret trends in their early development stage, enabling them to choose the optimal timing to enter the market. This approach provides traders with a range of tools based on statistical concepts, such as oscillators and indicators, and chart patterns based on interpretation.

By looking at the market charts, traders can identify the trend at a glance and subsequently confidently make their market entry by setting predetermined stop-loss limits to mitigate risk and setting potential price targets to book profits.


Happy trading!

author avatar image
Andreas Thalassinos

Experienced educator with a demonstrated history of working in the financial services industry. Skilled in Technical Analysis, Market Risk, Asset Management, Stock Market, and Trading Systems. Strong professional with a MSTA by Society of Technical Analysts (UK), CFTe and MFTA focused in Master of Financial Technical Analysis from International Federation of Technical Analysts (USA).

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