Technical analysis is a method of forecasting price movement based on historical chart data. At its core, this approach rests on the belief that all fundamental factors are already priced in, and that market history tends to repeat itself. This is why experienced traders study patterns rather than news.
Core Principles of Technical Analysis
Technical analysis is built on three postulates formulated by Charles Dow in the late 19th century:
- The market discounts everything. The price reflects the sum of all factors—economic, political, and psychological.
- Price moves in trends. A directed movement that has begun is more likely to continue than to reverse.
- History repeats itself. Market patterns recur again and again because the psychology of market participants remains unchanged.
Chart Analysis and Patterns
The simplest level of technical analysis involves studying price patterns directly on the chart without using additional indicators.
Reversal Patterns
These are figures signaling the conclusion of the current trend:
- Head and Shoulders — A classic pattern consisting of three peaks, where the middle one is higher than the two outer ones. A breakout of the "neckline" signals the start of a downward move.
Image of head and shoulders chart pattern
- Double Top / Double Bottom — The price tests the same level twice and bounces off it. This indicates significant resistance or support.
Image of double top and double bottom patterns
- Japanese Candlestick Patterns — "Hammer," "Engulfing," "Morning Star," and other single-day or multi-day candlestick combinations with high predictive value.
Trend Continuation Patterns
These figures form within an existing trend and signal its continuation after a pause:
- Flag and Pennant — Short-term consolidation after a strong move.
Image of bull flag and pennant patterns
- Triangles — Symmetrical, ascending, or descending. A breakout of one of the boundaries determines the further direction.
Indicator Analysis
Indicators are mathematical calculations applied to the price chart. They are divided into two main groups.
Trend Indicators
These work effectively in a directional market but give many false signals during sideways movement:
- Moving Averages (MA) — Smooth out price data to show the trend direction. The crossover of two moving averages with different periods is a basic trading signal.
- Bollinger Bands — A dynamic channel around a moving average. Price moving outside the channel often signifies the start of a new move or a reversal.
- Parabolic SAR — Dots above or below the candles that follow the trend. A shift in the position of the dots relative to the price is a signal of a direction change.
Oscillators
Oscillators work best in a sideways market, helping to identify overbought and oversold zones:
- RSI (Relative Strength Index) — Values above 70 indicate overbought conditions, while values below 30 indicate oversold conditions. RSI divergence from the price is one of the most reliable reversal signals.
Image of RSI indicator with overbought and oversold levels
- MACD — Combines properties of a trend indicator and an oscillator. The MACD histogram clearly shows changes in momentum.
- Stochastic — Measures the current price position relative to the range over a selected period. It is most effective when trading within a range.
Support and Resistance Levels
Levels are a fundamental tool of technical analysis. These are price zones where supply and demand previously came into balance. The more times the price has tested a level without breaking it, the more significant it becomes.
Key methods for plotting levels:
- Horizontal levels based on historical highs and lows.
- Fibonacci levels — Mathematical ratios (38.2%, 50%, 61.8%) applied to significant price moves. Widely used to find retracement points.
- Pivot Points — Calculated based on the high, low, and closing price of the previous session.
Wave Theories
Elliott Wave Theory suggests that the market moves in specific cyclic wave structures: five waves in the direction of the trend and three corrective waves. Accurately identifying the wave count allows for forecasting the scale and direction of the next move.
The Wyckoff Method describes the market through the behavior of "smart money"—large institutional players. Analyzing volume in combination with price action allows for the identification of phases: accumulation, markup, distribution, and markdown.
How to Combine Tools in Practice
No single technical analysis method provides 100% reliable signals. Professional traders use a multi-factor approach—confirming a signal with several independent tools:
- The trend is determined by moving averages or the ADX indicator.
- An entry point is found using an oscillator (RSI or MACD) or a candlestick pattern.
- A stop-loss is placed behind the nearest significant support/resistance level.
- The profit target is calculated using Fibonacci levels or the "measured move" of a pattern.
This comprehensive approach significantly increases the probability of a successful trade and helps avoid false entries.
Conclusion
Technical analysis is not magic, nor is it a guarantee of profit. It is a tool for probabilistic thinking that helps structure trading decisions. Mastering even basic methods—levels, moving averages, and one oscillator—already significantly improves trading quality compared to an intuitive approach.