What is Technical Analysis Tools For Trading? – Forbes Advisor UK

Investors are increasingly using technical analysis involving financial charts to potentially help them navigate the choppy waters of the stock market.

Here’s a closer look at technical analysis as a possible way to make money from the stock market.

What is technical analysis?

Technical analysis is the study of price movements using charts as a primary research tool. It stems from the Dow theory developed at the beginning of the last century by Charles Dow of the famous American industrial average stock market index.

To take such an approach, investors set aside ‘fundamental’ information about a company – income statements, balance sheets, profitability, business strategies, etc. – and instead rely on trading indicators and systems based on price charts.

What are trading indicators?

Trading indicators are mathematical calculations plotted as lines on price charts that help traders identify signals and trends within a market.

So-called ‘leading’ indicators attempt to predict future price movements, while ‘lagging’ indicators look at past trends and indicate patterns of momentum.

Focusing solely on prices, chart and technical analysts develop various trading indicators. Each of these indicators tells a story which then forms the basis of a particular buying or selling strategy.

For traditional investors, making such a mental leap can be a difficult maneuver. But for those willing to try these techniques, there are many resources to learn from.

These include educational resources available via online investment platforms and trading apps, to paid academic courses that take technical analysis to the next level.

TRADE INDICATORS

Trading indicators come in a variety of guises and it is up to the individual trader to decide how they best fit a personal investment strategy. At the most basic level, all you need to get started with technical analysis is a pencil, graph paper and stock price data.

For most people, a computer makes life easier, and many financial websites offer free charting features for users to experiment with.

The following terms are used to designate different types of indicators:

Trend: a term used to describe the persistence of prices to move in one direction. Identifying a trend is the most important concept in technical analysis. Volatility: a term used to describe the extent of day-to-day fluctuations in prices (independent of direction). Generally, changes in volatility tend to lead to changes in price. Momentum: a term used to describe the speed at which prices move over a given period of time. Generally, changes in momentum lead to changes in price. Cycle: many securities, especially derivatives known as ‘futures’, show a tendency to move in cyclical patterns. Price changes can often be expected at cyclical intervals.

Moving average

The ‘moving average’ or MA is an indicator used to spot the direction of a current price trend, without intervening for shorter-term price increases. The MA consists of price points of a specified financial instrument over a specified time frame and then divides it by the number of data points to produce a single trend line.

The data used depends on the MA’s timeframe. For example, a 100-day MA requires 100 days of data. By using the MA as an indicator, it is possible to study levels of ‘support’ and ‘resistance’ and observe past price action by looking at the history of the market.

Support is the point in a security’s trading profile where its price regularly stops falling and bounces back, while resistance is where a price normally stops rising and starts falling.

By smoothing out price fluctuations, MA can help traders discern underlying trends and gauge overall market sentiment.

Exponential moving average

Another form of MA, but this one that assigns more influence – or weight – to recent data points and less to old numbers due to a weighting variable in the calculation.

This makes exponential moving averages more responsive to new information. When used in tandem with other indicators, exponential moving averages can help traders confirm significant market movements and gauge their legitimacy.

There are other, more complicated moving average calculations, but MA and exponential MA are the most common.

Moving average crossover strategy

The MA crossover strategy is based on the idea that when two moving averages of different periods cross each other, it indicates a potential change in market trend.

A crossover occurs when a short-term MA crosses a long-term MA. The short-term MA is more sensitive to recent price changes, while the long-term MA is less sensitive and provides a smoother representation of the price trend. When these two measures cross each other, it can indicate a shift in market sentiment, suggesting that the trend may reverse or accelerate.

Stochastic oscillator

A stochastic oscillator is an indicator that compares a specific closing price of an asset to a range of its prices over time, showing both momentum and trend strength. This measure uses a scale of 0 to 100, where a reading below 20 usually represents an oversold market, while one above 80 suggests an overbought market.

Bollinger bands

A Bollinger Band is an indicator that provides a range within which the price of an asset typically trades. The width of the band increases and decreases to reflect recent volatility. The closer the bonds are to each other, or the narrower they are, the lower the perceived volatility of the financial instrument in question. The wider the bands, the higher the observed volatility.

Fibonacci retracement

Fibonacci retracement is a technique used in technical analysis to predict future areas of support or resistance after a significant market move. It involves using a charting tool that highlights potentially significant price action levels based on Fibonacci theory.

This theory centers around the ‘Fibonacci sequence’, a sequence in which each number is obtained by adding together the two previous entries. The sequence starts with a zero and a one. When you add them together, you get 1. Then one plus one equals two, two plus one equals three, three plus two equals five, and so on.

The Fibonacci sequence then continues to look like this: 0,1,1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233 … to infinity.

For traders, the main aspect of Fibonacci theory lies in the ratios derived from the figures within the sequence. Dividing each number in the sequence by the one following it always produces a ratio of 0.618 when the numbers in the sequence are large enough. Multiplying a larger number by the one preceding it yields a figure of 1.618, also known as the golden ratio.

These ratios occur across different branches of mathematics and Fibonacci traders use them to predict potential upcoming price reversals and breakouts.

Ichimoku Cloud

Also known as Ichimoku Kinko Hyo, the Ichimoku Cloud is a popular technical indicator developed by journalist Goichi Hosoda in the 1930s. It was released to the public in 1969 and is still used by traders today.

The indicator remains popular in Japan, and there is a theory that it works better when applied in foreign exchange terms to Japanese Yen currency pairs and also to the Nikkei, the Japanese stock index.

Translated into English, the indicator means ‘at-a-glance equilibrium chart’, as traders can derive a variety of information points from it.

Use trading indicators

It is wise to never use trading indicators in isolation or, indeed, too many at once.

A solid tactic is typically to concentrate on a few that you think best suit your personal trading needs and what you’re trying to achieve in general. Whenever possible, use technical indicators in tandem with your interpretation of the movement of an asset’s price over time. This is known as the ‘price action’.

If you end up getting a ‘buy’ signal from an indicator but a ‘sell’ signal from the price action, then something is not right and you will probably need to use different indicators – or time frames – until the signals are both confirmed .