Part 27 Technical Analysis – Using Order Book

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Technical Analysis Strategies for Beginners

Many investors analyze stocks based on their fundamentals – such as their revenue, valuation or industry trends – but fundamental factors aren’t always reflected in the market price. Technical analysis seeks to predict price movements by examining historical data, mainly price and volume.

It helps traders and investors navigate the gap between intrinsic value and market price by leveraging techniques like statistical analysis and behavioral economics. Technical analysis helps guide traders to what is most likely to happen given past information. Most investors use both technical and fundamental analysis to make decisions.

Choose the Right Approach

There are two different ways to approach technical analysis: the top-down approach and the bottom-up approach.   Often times, short-term traders will take a top-down approach and long-term investors will take a bottom-up approach.

  • Top-Down. The top-down approach is a macroeconomic analysis that looks at the overall economy before focusing on individual securities. A trader would first focus on economies, then sectors, and then companies in the case of stocks. Traders using this approach focus on short term gains as opposed to long term valuations. For example, a trader may be interested in stocks that broke out from their 50-day moving average as a buying opportunity.
  • Bottom-Up. The bottom-up approach focuses on individual stocks as opposed to a macroeconomic view. It involves analyzing a stock that appears fundamentally interesting for potential entry and exit points. For example, an investor may find an undervalued stock in a downtrend and use technical analysis to identify a specific entry point when the stock could be bottoming out. They seek value in their decisions and intend to hold a long term view on their trades. (For related reading, see: Bottom-Up and Top-Down Investing Explained.)

In addition to these considerations, different types of traders might prefer using different forms of technical analysis. Day traders might use simple trendlines and volume indicators to make decisions, while swing or position traders may prefer chart patterns and technical indicators. Traders developing automated algorithms may have entirely different requirements that use a combination of volume indicators and technical indicators to drive decision making. 

Part 27: Technical Analysis – Using Order Book

JC Parets is the Founder of “All Star Charts” and is one of the most widely followed Technical Analysts in the world. His work has been regularly featured on Bloomberg, CNBC, Fox Business, ABC, CNN, and The Wall Street Journal, among other outlets. JC has been helping both professionals and retail investors identify winning trades for over 10 years, and with Technical Analysis – his first course for Investopedia Academy – JC takes this powerful market perspective and makes it useful for anyone in the world.

Students are Saying.

The way JC explains the details of Technical Analysis to a beginner like myself is amazing and the content is so rich. I can already apply the information in this course to my swing trading strategy. I am now able to identify my past mistakes and am making better trading decisions because of it.

I am really enjoying the Technical Analysis course. They have a great professor that is simple and easy to understand, especially for a beginner like me!

Investopedia’s Technical Anlaysis course has taught me a lot of new information and is also reinforcing my prior knowledge on trading. I am even applying the knowledge I gained from this course to my cryptocurrency trading.

I have learned a lot from Technical Analysis and am already applying what I have learned!

Technical Analysis

What is Technical Analysis?

Technical analysis is the interpretation of the price action of a company’s underlying stock (or any tradable financial instrument). It utilizes various charts and statistical indicators to determine price support/resistance, range and trends. It identifies historically relevant price patterns and behaviors to help forecast potential direction of the stock. This methodology focuses only on the price of the shares, not the operations of the company.

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How Does Technical Analysis Work?

By using historical price data, technical analysis attempts to interpret the supply and demand that moves share prices. Dinosaurs can’t walk in the sand without leaving footprints. The dinosaurs are the institutions, mutual and hedge funds. They are the participants that move stock prices. Technical analysis visually tracks the activity of the dinosaurs using various charts and indicators to pinpoint price areas of strong interest both in terms of buying and selling. History tends to repeat itself as evidenced by price patterns.

Who is Technical Analysis For?

Anyone who trades or invests in the stock market or any other tradable financial instrument should consider learning at least a basic level of technical analysis. It your money is invested into a position that has price movement, then technical analysis will help you make better-informed decisions as to how much risk to employ for how much potential reward.

Stocks represent the underlying company’s business and operations. However, the perception and future valuation of the company and its performance is reflected into its stock price. There is often a divergence between the two. Technical analysis also helped to determine where the divergence lies and how much opportunity may exist.

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Basics of Technical Analysis

Technical Analysis can be applied to all different chart types.

Technical analysis involves and utilizes various tools and indicators. The right mix of the tools can be used to generate converging signals that improve the probability of a direction price move.

Stock Charts

Technical analysis seeks to interpret the story of a stock’s price action. Charts act as the canvas where the story is painted. The common types of charts are candlestick, bar and line charts. Charts plot the prices where trades have been executed. The time interval of the chart can be specified through the settings. Time intervals segment the price action of the stock. For a 5-minute candlestick chart, each candle represents a five-minute segment of trading that record the starting price (open), the highest price (high), lowest price (low) and last price (close) trade during the period. As the five minute window ends, it will display a candlestick that details the four data points (open, high, low, close) and a fifth data point that encapsulates the opening and closing price (body) and colors the body red if the last trade (close) is lower than the first trade (open), or green if the last trade (close) has a higher price than the first trade (open). Bar charts include the same information without painting the body. Line charts simply connect the closing price only for each time period.

Support/Resistance

By visually marking the charts, users can see certain price levels that tend to prevent prices from falling any further before rising back up again. These are known as price support levels. Users will also spot price levels that continue to provide a ceiling, that eventually causing prices to fall back down again after testing. These are known as price resistance levels.

Stock Volume

Volume measures the total number of shares traded for a specified period of time. It is used as a measure of interest that can manifest into significant price action. High volume indicates significant trading activity that triggers a breakout or a breakdown accompanied by a sustaining trend in prices. Breakouts result in higher trending prices and breakdowns result in lower trending prices. When volume is light, stocks tend to chop around in a range known as consolidation.

Trends indicate the current direction of share prices. When stock prices continue to rise higher, it is considered to be in an uptrend and vice versa for a downtrend. Uptrends indicate increasing demand for shares, as buyers are willing to pay higher prices as supply diminishes. Downtrends represent an oversupply of shares with waning buying interest resulting in falling prices. By connecting the various high and low points on a chart, you can manually generate trendlines that pinpoint support/resistance and direction of stock prices. When compared to historical templates of similar trendlines, you may be able to forecast the future direction, turning/inflection points and targets.

Trend lines can be used to summarize the general sentiment surrounding a stock, whether it is bullish, bearish, or neutral.

Technical Indicators

Having the data points plotted on a chart helps to eyeball the direction of stock prices, but deeper analysis requires more data crunching. What may have taken hours by hand in the old days can be processed in seconds thanks to the multitude of technical indicators on today’s charting and trading platforms. Trends can be visually tracked with indicators like moving averages, which are dynamic lines that connect each period’s closing (last) price. Charting/trading platforms enable users to manually draw in their own trendlines directly onto their charts. Different traders may have different trendlines based on the time frame of the chart as well as the starting point.

Technical indicators can be used to organize, summarize, and analyze price and volume data for improved decision making.

Price indicators

Indicators that output price-based information like trends, support and resistance are price indicators. They are usually displayed and tracked on the price portion of a chart, usually the upper chart. Moving averages, candlesticks/bars/lines, Ichimoku clouds, point and figure, pivot points, three line break and Renko bars are all popular price indicators. Trendlines and trend channels are either manually or automatically drawn are strong price indicators as well.

Momentum indicators

Indicators that measure the momentum of a stock including overbought and oversold conditions are momentum indicators. Basic momentum indicators come pre-programmed in most charting/trading platforms. These indicators help traders to better time their entries and exits. When properly used, traders are able to avoid chasing prices when momentum indicators show overbought conditions like a stochastics peaking and falling back under the 80-band. While price is important, understanding how the price level is achieved can be just as significant. Stochastic, Relative Strength Index (RSI) and Commodity Channel Index (CCI) are three widely used momentum indicators.

Using a combination of price and momentum indicators can help generate effective entry and exit signals. The science of successful trading utilizes the right mix of technical indicators to generate high probability set-ups and triggers married with prudent disciplined trade management. Technical indicators optimize the process of price analysis.

Introduction to Technical Analysis Video Course

For further information on technical analysis, review this segment of the Investors Underground free beginners day trading course.

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