As I’m sure almost everyone knows, the goal of technical analysis is to predict the future prices of stocks and other financial assets.
Technical analysts do this because predicting where prices will go can be potentially very profitable.
If you’re wondering how technical analysis works, don’t worry!
First off, there are many different ways in which people try to predict things using technical analysis. Some methods work better than others, but all methods have one thing in common: Extracting information from past market data (price changes).
There are two broad types of technical analysis: charting and vectorscope.
Let’s start with the simplest method, which is also the one that most people are familiar with.
Charting involves analyzing charts for patterns where prices have moved up or down in the past. If a specific pattern keeps repeating itself over time, it will be called an “indicator” (you can think of it as a signal to buy or sell).
There are hundreds of possible indicators, but I’ll only cover the most popular ones here. These indicators usually come as a series of steps to follow– if you do what the indicator tells you to do at every step, you should make a profit!
Before we get into that, though, we should probably go over what a chart is and how to read it.
A chart is simply a visual representation of price data (you can think of it as the way stocks make when they move up or down). Why do you want to know how stocks make when they move? Because this movement, when repeated over time, creates patterns in charts that can help us predict future movements!
Still not sure; look into Saxo capital markets for a better understanding.
Now let’s look at some indicators:
Average Directional Index
This indicator tells us how strong a trend is. If you see lots of green dots and lots of red dots close together, then the chances are good that prices will continue going up as they have been, as indicated by the tight clustering of green dots.
If you see lots of red dots close together and a bunch of green dots far apart, this usually means that the trend has been going down, as indicated by the tight clustering of red dots.
Relative Strength Index
The RS line shows how strongly stocks are moving up or down. A good thing to look for in the STICK is a certain distance between a stock’s lowest and highest prices ever (we’ll call this “distance” x ). When we find instances where x is getting farther away from 0, then that means that something has been pushing prices further away from their mean– so you want to buy! On the other hand, if x keeps coming closer to0, then that means that whatever is pushing prices away from their mean is less intense than before– so you want to sell!
Williams Percent Range
This indicator tells us whether investors are pessimistic or optimistic. If the indicator is far above 0, it means people are optimistic (and they should be buying because the price will go up!) If the indicator is far below 0, it means people are pessimistic (so you should sell!).
A good thing to look for in the Williams Percent Range Stick is clustering around 0. It usually means that things aren’t changing very much– but if something suddenly pushes one standard deviation out of line with this clustering, then you should buy or sell depending on what your goal is!
The MACD indicator tells us the relationship between recent stock price changes and longer-term stock prices. The idea is that if a stock has been going up for a long time, it probably won’t go up much more. We call this “momentum”, and we can track it by seeing how last month’s high price compares to this month’s high price (this is called “the difference”).
If there is little momentum, then the chances are good that next month’s high will be similar to this month. If there is lots of momentum, next month’s top might be very different from this month’s top!