STEP 1: CANDLES
As a precursor to starting you out on your technical analysis journey, I would like to introduce the concept of Candlesticks to you. These are similar to Bar charts, but Candlesticks are more graphic in that they display a range of information that is often critical for traders to see at a glance. In addition to opening and closing prices, Candlesticks display high and low price statistics.
In the above chart, the filled black bar indicates that the share closed weaker than its opening price. However, if the closing price is higher than the opening price, then the block in the middle will be white or hollow.
Note that the top of the block is the opening price and the bottom of the block is the closing price. If you are to use Candlesticks as your preferred “line” to display shares and other securities, then it is important to learn the following:
If the closing price is above the opening price, then a hollow Candlestick is drawn. If the closing price is below the opening price, then a black filled Candlestick is drawn. The hollow or filled section of the candlestick is called the "Real Body".
The thin lines above and below the Body displays the High/Low range. These lines are called Shadows.
The top of the Upper Shadow is the High, while the bottom of the Lower Shadow is the Low. Long bodies indicate strong buying or selling activity.
Selling or buying pressure is indicated by a longer body, while short bodies imply poor buying or selling activity.
Upper Shadows signify the session high and lower shadows signify the session low.
The purpose of using Candlestick charts is to effectively see basic price statistics in graphic form. I recommend that traders get used to using these charts instead of the normal line charts as:
Candlesticks are easy to view and thus interpret. They are perfect starting charts for the novice trader to start his or her chart analysis.
Candlesticks no more difficult to draw than other line forms . Simply click the button on your trading stock package that states “Candlesticks” and unclick the Price button.
Candlesticks are excellent tools to identify reversals from an uptrend to a downtrend or a downtrend to an uptrend.
There are many different types of Candlestick patterns and patterns can be single, dual and triple candlestick formations. Professional traders usually combine candlestick analysis with support and resistance levels to obtain better trading signals or triggers.
Now that we have covered the preferred diagram method, let us move to the business of technical analysis. Step 2 looks at how we determine a trend.
STEP 2: IS THERE A TREND?
Trend lines are simple and straight lines drawn that touch three points on a graph. If drawn correctly, trend lines can be as accurate as any other method, but many traders make the mistake to trying to make the line fit their strategy.
Therefore, an uptrend line is drawn along the bottom of easily identifiable support areas, called valleys.
In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas, called peaks.
How do you draw trend lines?
To draw trend lines properly, all you have to do is locate three major tops or bottoms and connect them. The following highlight up, down and sideways (also ranging trends)trends.
Note the following:
Two points touching a line at the top and at the bottom defines a valid trend line However, if three or more points touches the line, the trend is confirmed.
Trend lines are strong indicators when many points touch the line, but these become less reliable if the line is very steep.
STEP 3: WHAT ARE THE SUPPORT & RESISTANCE LEVELS?
Also extremely easy to draw, Support and Resistance lines have become widely and popular used signals in trading. Let's take a look at the basics first.
In the above chart, the share price is moving strongly upwards, bouncing off the support and resistance levels. It can be said that the share is in a bull run as each Support level is getting progressively higher. This is also called Higher Lows, as each day’s lowest price is actually higher than the previous day’s lowest price.
In addition, the Resistance level is also getting progressively higher. This is also called Higher Highs, as each day’s highest price achieved by the company is actually higher than the previous day’s highest price.
There are a number of exceptions, which tend to be better viewed when using Candlesticks. There will be times when a share seems to break through its Support or Resistance level, only to resume its previous trend. Experts suggest that this a possible change in investor sentiment and the share is now testing Support or Resistance levels.
How do novice traders know if support and resistance has really been broken?
Unfortunately, there is no definite technical answer, other than to use the break as a warning that a Support or Resistance Level may be broken. One possible way is to have multiple Support and Resistance lines, which some experts call Zones.
The above graph highlights some interesting aspects:
When the price passes through the first support level, the share moves higher to form a new Support/Resistance Level. As such the Support level became its new Resistance Level.
When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.
When the market moves up and then falls back, the highest point reached before the share falls back is the resistance. The share As the market continues up again, the lowest point reached before it climbs back is now support. One thing to remember is that horizontal support and resistance levels are not exact numbers.
Now that the basics of trend lines and Support/Resistance levels have been set out, let’s look at how to apply these in trading. There are two simple trading techniques, namely the Bounce and the Break.