Technical Analysis for beginners — part one (Charts, Candles, Volume)
Welcome everyone,
This is the first of many articles that will be focused on Technical Analysis (TA), charting and how to use those tools to increase profits and chances of successful trading and investing. Our goal is to explain how to use these tools in simple words. In this article we will start with the basics of TA, its crucial components and how to read the charts, so let’s dive in. By Investopedia definition:
“Technical Analysis is a trading discipline used to evaluate investments and identify trading opportunities in price trends and patterns seen on charts”
There are two primary methods used to analyze securities and to make investment decisions, fundamental and technical analysis. Unlike fundamental analysis, TA focuses only on the study of the price and volume, with a belief that the past trading activities and price changes can be valuable indicators of future price movements. Technical analysts also assume that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements.
Technical Analysis can be used on any security with historical trading data where the price is influenced by the forces of supply and demand: stocks, commodities, futures, bonds, currencies and many others. Many Technical Analysts use charts to identify current price trends, support and resistance levels, short term price movements, and all that to identify patterns and trends that suggest what a stock will do. To become more profitable and more successful in trading, today many indicators can be used on charts and which can help to identify those patterns, from simple ones to more complex versions.
For many people just a mention of Technical Analysis creates a lot of confusion, but don’t worry, in this first article we’ll break down all the basic concepts of TA, so You can learn how to read the charts and what they represent.
Charts
Charts are graphical presentations of price information, they plot historical data based on the combination of the price, volume and time intervals. Every chart in the technical analysis comprises two axes, time and price. Those movements between axes are presented with candles, lines or bars. In this example, we will use candles, although today we have many variations of price presentations and movements.
As we can see in the chart above, the bottom axis presents time, while the right axis presents the price. The price movement between those axes is painted in candles. The chart above presents the popular SPX index and its price movement in the 2000 and 2008 crisis. So, when we look at it, what do we notice? In both of the crisis, price acted similarly, almost reaching $1600 and then again dropping by approximately 50%. You are probably wondering so what, how does this help me? Well, in 2000 when the price dropped from $1550 to $780, for Technical Analysts chart painted resistance (sellers zone) and support levels (buyers zone):
Now we have two very important levels to monitor if the price reaches them again. Let’s see what happens next.
That’s right, the price in 2008 reached the same level as in 2000, and it dropped just to found the support in the green box again! Once the buyers stepped in at those levels, the price eventually reached new higher levels. There are numerous ways to define important zones using Technical Analysis, this is just one of them. If used correctly, TA can become a powerful tool that can with the right strategy and risk management help you make consistently profitable decisions in the long-term future.
Candles
Now when we know the basic components of every chart, let’s move to candles. Which information one candlestick gives? When the price moves from one candle to another, it marks Open and Close price. Movement between open and close is called Body, and that is the true price range where most trading happened for the selected period.
High and Low points are also called Shadows or Wicks. Those are the lowest and the highest points of the price for the period. Never underestimate how much information one candlestick can give. There are many candlestick patterns on which we will focus in future articles.
Every candle represents a price movement for the selected period. The time frame can be based on intraday (one to 30 minutes or hourly), daily, weekly or monthly price data. If the price was negative before the last candle, the next candle will traditionally be painted in red color, signaling a decrease in price, while the green candle signals an increase in the price. Every trader can decide which candlestick colors to use, and we’ll be using green and black candles in our articles. So let’s compare how the same period looks at different time frames:
Every trader and investor use time frames which suit their trading and investing style the best, higher the time frame more reliable are the patterns. If we want to see higher time frames, we “Zoom Out” and when we want to see smaller time frames, we “Zoom In”. Over time you will learn which one works for you and your strategy.
Volume
The last on our list today but not less important is Volume. Let’s start by explaining what is Volume: Volume is the total number of buyers and sellers exchanging shares over a particular period. Looking at volume patterns over time can help get a sense of the strength of conviction behind advances and declines in specific stocks and entire markets. Volume charts are usually available below a standard candlestick graph. When the price increases or decreases and is followed up by a larger volume than usual, that price movement has more significance, and when the volume is low vice versa. There are many volume indicators, but today we will focus on the basic one.
On the charts above under the candlesticks, we can see the volume indicator. Analysts often combine Volume with other trading indicators to increase the chances of successful trades and investments.
Summary
Technical analysis is mostly focused on the psychological aspect of the market and technical analysts believe that the current price fully reflects all available information.
Many people do not understand the basic concepts of technical analysis and consider it as divination. Do not get confused, TA is not meant to foresee the future price movements, it’s meant to help traders and investors to anticipate what is likely going to happen to price over time. Combining different indicators to detect important price actions and zones, and then developing proper strategies with the right risk management can result in profitable trades and investments. In the next couple of articles, we will focus on some basic indicators and patterns, and after that, we’ll learn how to combine all of them into more reliable trade setups.
The more you study technical analysis, the more you will understand how it works, and how it can help you to become more profitable and successful in investing and trading.
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