Profile TradersTechnical Analysis for Beginners in Indian Financial Markets 2022
Updated: Feb 12
Technical Analysis is the study of historical price movements to identify known repetitive patterns and determine future price movements' probabilities through the use of technical concepts, technical indicators, and other analysis tools.
Technical Analysis, in general, is a vast subject as any technical concept used in share market trading and investing falls under it.
Below are some of the crucial aspects of Technical Analysis.
Price chart Patterns
Technical Indicators
Candlestick Patterns
Support and Resistance
Types of Trading
Let us explore all these aspects one by one.
Table of Content
How does Technical Analysis work?
Technical Analysis vs. Fundamental Analysis
Different chart Types in Technical Analysis
Important Chart Patterns in Trading
Getting Started in Technical Analysis
What are Support and Resistance?
Important Candlestick Patterns in Trading
Best Technical Indicator for Day Trading
What are the Good Books on Technical Analysis?
Software for Technical Analysis
Free Online Course on Technical Analysis
Popular Topics
How does Technical Analysis work?
Technical Analysts don't consider any aspects of fundamental factors for their trading. They believe only past information of 'Price' and 'Volume' of a stock is enough to predict the future movements.
Technical Analysis works on a few vital assumptions:
Price consists of all the Information – Any open or hidden information about stock will reflect in the price of the particular stock.
For example, a key person in a company came to know that his company will be benefitted immensely due to a new contract.
Hence, he decides to accumulate some shares with the help of others (insider trading or buying) for quick gains.
His accumulation results in extra volume compared to daily average volume and push the price on the upside.
Hence, a technical analyst can quickly notice these changes in the price and volume.
Price displays different Trends - A price can move in different trends along with time.
There are three types of trends:
Uptrend
Downtrend and
Sideways Trend
A stock price can be on an uptrend for a few months. Later it can change the direction and can move in sideways or downtrend.
Understanding these trends and identification of the change in trend early can offer significant benefits to traders.
History trends to repeat – Only two factors drive the stock market – 1) Greed and 2) Fear.
Irrespective of change in the world's economy and advancement in technology, people make their trading decisions based on emotions. Hence, the same patterns appear again and again.
Technical Analysis vs. Fundamental Analysis
Fundamental analysis focuses more on qualitative aspects such as PE ratio, balance sheet, cash flow, debt-to-equity ratio, etc. They use all this fundamental information to arrive at the Intrinsic Value of a company.
If the stock price is undervalued, then fundamentalists plan to accumulate the shares assuming the price will reach its value in some time.
Technical Analysis focuses on price and volume. Technical traders use only this information to manage their trades.
Is Technical Analysis useful?
When you drive in unknown terrain, it is better to use Google Maps. Because most of the time, it will guide you in the right direction.
Similarly, if you are new to the share market, it makes sense to use technical analysis to guide you in the right direction.
Many people downgrade the importance of technical analysis. But what they forget is traders don't lose money because of technical analysis, but they lose money because they fail to apply proper aspects of technical analysis with discipline.
Different chart Types in Technical Analysis
The price is represented in many chart patterns. Some of the vital chart types are below:
Line chart
Bar chart
Candlestick chart
Renko chart
Point and Figure chart
Heikin Ashi chart
Kagi chart
The Candlestick chart is the most popular and visually appealing. Hence, it is better to use a candlestick chart for the analysis.
For more information on other chart types, please read 'Different chart types.'
Important Chart Patterns in Trading
Chart patterns are an essential aspect of technical analysis, but people need to study them for some time to identify them in the live market.
A chart pattern is a known shape within the price chart and predicts how the price can move later.
Below are some of the crucial chart patterns.
Head and Shoulder Pattern
Head and Shoulder is a bearish chart pattern.
It has a large peak at the center and two minor peaks on either side of it.
Once the third peak breaks the neckline, it indicates that the prior uptrend is over and the beginning of a downtrend.
Many technical analysts target the height of the head (from the neckline) on the downside.
Inverse Head and Shoulder Pattern
The Inverse Head and Shoulder pattern is similar to Head and Shoulder, but it is a bullish chart pattern.
It has a large peak at the center and two minor peaks on either side of it.
Once the third peak breaks the neckline on the upside, it indicates that the prior downtrend is over and the beginning of the uptrend.
Technical analysts target the height of the head (from the neckline) on the upside.
Cup and Handle Pattern
The cup and handle is a bullish continuation pattern.
It appears in the stocks which are in a strong uptrend. The cup looks similar to the rounding bottom pattern, and it indicates the buildup.
After the formation of the cup, it gives a minor retracement which is nothing but a handle.
The break of the handle indicates all the selling has been negated, and the price is ready to give a good move on the upside.
Technical analysts target the height of the cup (from the neckline) on the upside.
Bull Flag Pattern
The bull flag is also a bullish continuation pattern.
It appears in the stocks which are in a strong uptrend. It forms a 'pole' first, which indicates a swift rally on the upside.
After the formation of a pole, it gives a minor retracement that looks like a flag.
The break of the flag indicates all the selling has been negated, and the price is ready to give a good move on the upside.
Traders keep the height of the pole as their target on the upside.
Bear Flag Pattern
The bear flag is similar to the bull flag but on the opposite side. It is a bearish continuation pattern.
It appears in the stocks which are in a strong downtrend. It forms a 'pole' first, which indicates a swift fall on the downside.
After the formation of the pole, it gives a slight bounce which looks like a flag.
The break of the flag indicates all the buying has been negated, and the price is ready to give a good move on the downside.
Traders keep the height of the pole as their target on the downside.
Triangle Pattern (symmetrical, ascending, and descending)
A triangle pattern is a consolidation pattern between the trend and indicates the continuation of the existing trend.
There are 3 variations in the triangle pattern:
Symmetrical Triangle
Ascending Triangle
Descending Triangle
The above image shows an example of a symmetrical triangle pattern.
Earlier, the price was in a strong uptrend. Then it displayed sideways consolidation for some time.
During the consolidation, it made swing lows and highs within the triangle. At one point, it broke the triangle pattern and continued its rally on the upside.
The above image shows an example of ascending triangle pattern.
Earlier, the price displayed sideways consolidation for some time.
During the consolidation, it made swing lows and highs within the triangle. It made all the highs at the same level, but all lows at a higher level. It is a critical characteristic of ascending triangle.
At one point, it broke the triangle pattern and rallied on the upside. Traders take the triangle's width (from high to low) and target the same level as their target after the breakout.
The above image shows an example of descending triangle pattern.
Earlier, the price displayed sideways consolidation for some time.
During the consolidation, it made swing lows and highs within the triangle. It made all the swing lows at the same level, but all swing highs at a lower level. It is an essential characteristic of a descending triangle.
At one point, it broke the triangle pattern and started falling. Traders take the width of the triangle (from high to low) and target the same level as their target after the breakdown.
Technical Indicators
We have 1000s of technical indicators in technical analysis. All technical indicators available in the stock market are derived using different types of calculations from the same price information: open, close, high, low, and volume.
Technically, all indicators can be divided into 4 types, as shown below:
Trend indicators.
Momentum indicators.
Volatility indicators.
Volume indicators.
Trend Indicators
Usually, trend-following traders use trend indicators to support their trading views.
Moving averages (MA), MACD, average directional index (ADX), parabolic SAR (PSAR), and linear regression are some examples of trend indicators.
These indicators are designed to show the direction and strength of any stock or index. The direction of the trend can be upwards, downwards, or sideways.
These are all lagging indicators.
This video explains a simple method to use ADX Indicator.
Momentum Indicators
These indicators are used to measure the speed (or momentum) of stock in a given period.
Short-term traders focus on stocks that move significantly in one direction to make quick money. For this reason, they use momentum indicators like RSI, Stochastics, CCI (Commodity Channel Index), and Williams %R.
Below are the 2 widely used, essential characteristics of momentum indicators:
Overbought and oversold conditions.
Bullish and bearish divergences.
Usually, overbought and oversold conditions predict the end of a trend and take the trades in the opposite direction of the existing trend.
For example, if a momentum indicator shows an overbought condition for a stock, traders will look to sell it.
Similarly, divergences are used to pick the end of a trend by identifying its weakness and to make trades in the opposite direction of the trend.
Volatility Indicators
Volatility is the relative rate at which the price of a security moves up and down.
A high volatility condition is suitable for short-term traders. Because of this, many volatility indicators such as Bollinger Band (BB), Average True Range (ATR), Donchin channel, and volatility Chaikin have been developed.
Volume Indicators
The volume plays a crucial role in trading. A trend with a high volume indicates that the probability of the price moving in the direction of the trend is high. Hence, this can be used to confirm a trend or trend reversal.
A few examples are the money flow index, Chaikin money flow, force index, and on-balance volume.
We will explore some of the popular indicators which are widely used/discussed in the trading community.
MACD Indicator
MACD acts as both trend following and momentum oscillator. Technically it belongs to the momentum oscillator category. However, it is not typically used to identify overbought and oversold situations like any other oscillator.