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Basics of Technical Analysis

  1. Basics of Technical Analysis

    This article is dedicated to cover the basics of technical analysis and then progress step by step to the advanced concepts so that, by the end of this series of blogs, we will be able to interpret and trade any kind of chart.

    Even those who have prior experience in trading should not skip the following section. It contains a different approach that is not often addressed in conventional technical analysis and it is a prerequisite for successful price analysis.

    Line Charts
    For most people, line charts usually provide the first impression of the world of financial markets because we frequently see them on the news and on our television/desktop screens.

    A line chart can describe the price development of a stock, a currency pair, a cryptocurrency, a commodity and any other financial instrument over time.

    The advantage of a line chart is that the information is highly compressed. One glance at a line chart tells you all you want to know for elementary analysis.

    If we see a rising line chart, it indicates a rally or a bull market. If the line chart shows a falling price, it indicates a bear market.

    We move one unit to the right on the chart. The unit time can vary from 1 second (intrday line chart) to 1 year. Line charts with a unit time of 1 day are also called a daily chart.

    The disadvantage of a line chart is that the price fluctuations within the chosen unit time cannot be recorded since the line chart shows only the closing prices.

    However, we all know that there can be strong price fluctuations in the financial markets and neglecting them can be a disadvantage for precise technical analysis.

    BPCL Line Chart showing Bearish Trend on a 1-D time frame
    Candlestick Charts
    Candlestick charts are further developed line charts that serve to compensate for the disadvantage of less information. Candlestick charts have their origin in 17th century Japan.

    Today, candlestick charts are preferred tool for analysis for most traders and investors as they provide all the information at a glance.

    The Candlestick
    As the name suggests, a candlestick chart is made up of so-called candlesticks. These candlesticks are in turn made up of different components to describe price movements of financial instruments.

    The below figure shows that a candlestick consists of a solid part, the body and two thinner lines which are called candle wicks or candlestick shadows.

    A Bullish Candlestick on the left and a Bearish Candlestick on the right along with explanations of terms used for individual candlestick components
    The candlesticks are color-coded to illustrate the direction of the price movements. A green candlestick represents rising prices, whereas a red candlestick represents that the price fell during that period.

    The length of the shadows shows how much the price has moved up and down with respect to a candlestick within a specific duration. If we set our charts so that one candlestick corresponds to one day, then we can read the daily price fluctuations in the financial market using the shadows of a candlestick.

    The candlestick body describes the difference between the opening and closing prices for the corresponding time period.

    The trend of candlesticks from the opening price to the closing price is shown by the candlestick body. The shadows show the entire fluctuation width.
    The body of the white, rising candlestick shows that the price opened at Rs. 10 and closed at Rs. 20 in the selected time interval, but has fluctuated between Rs. 5 to Rs. 25 in the meantime, as indicated by the shadows.

  2. Technical analysis works on the basis of support and resistance. Thus, it is important to find out the support and resistance of the stock in order to trade in it.

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