‘Securities’ is a term that refers to a fungible financial instrument that holds a certain type of monetary value. It is representative of an ownership position in a corporation that is publicly traded by way of stock. Alternatively, it represents either a creditor relationship with a governmental body or corporation or rights to ownership that an option represents. Securities are put into two distinct categories: ‘equities’ and ‘debts.’ You will also see hybrid securities that combine elements of both of these categories.

When it comes to analyzing securities – and making smart investment decisions in general – there are two primary methods. Those are ‘fundamental analysis’ and ‘technical analysis.’

What are they?

Fundamental analysis is a method that tries to measure a security’s intrinsic value. It does this by examining analogous economic and financial factors, which can be both qualitative and quantitative in nature. Fundamental analysts study anything and everything that can affect the security’s value. These frequently include macroeconomic factors (ex. economy and industry conditions) and microeconomic factors (ex. financial conditions and company management).

The ultimate goal of fundamental analysis is to produce a quantitative value that an investor can compare with a security’s current price. This will consequently indicate whether the security is undervalued or overvalued.

Technical analysis is a trading discipline that evaluates investments and identifies trading opportunities. It analyzes statistical trends that draw from trading activity, such as price movement and volume. Technical analysts, unlike fundamental analysts, focus on patterns of price movements, trading signals, and various other analytical charting tools. It does this in order to gauge a security’s strength or weakness.

Furthermore, technical analysis can be useful on any security with historical trading data. Such securities include stocks, futures, commodities, fixed-income, currencies, and various other types.

Basically, fundamental analysis involves examining a company’s financial statements to determine the fair value of the business. Conversely, technical analysis assumes that a security’s price already reflects all publicly-available information. Thus, it instead focuses on the statistical analysis of price movements.

On the surface, the technical analysis appears to be overly complex. In actuality, it boils down to an analysis of supply and demand in the market. This will help determine the general direction of the price trend.

This article will better explain this analysis method, while also further illustrating the difference between it and fundamental analysis.

The Dow theory

Technical analysis, as we are familiar with nowadays, came to be in the late 1800s by Charles Dow. Moreover, its creation also stems from the Dow theory. Several noteworthy researchers including William P. Hamilton, Robert Rhea, Edson Gould and John Magee were contributors to the Dow theory concepts. They were responsible for effectively forming its basis. In the contemporary era, the technical analysis includes hundreds of patterns and signals that come from years of research.

Investopedia editor, Adam Heyes, explains Dow theory as the following:

The Dow theory is a theory that says the market is in an upward trend if one of its averages (industrial or transportation) advances above a previous important high and is accompanied or followed by a similar advance in the other average. For example, if the Dow Jones Industrial Average (DJIA) climbs to an intermediate high, the Dow Jones Transportation Average (DJTA) is expected to follow suit within a reasonable period of time.”

Charles Dow wrote a string of editorials that discuss technical analysis theory. His writings include two basic assumptions that proceed to assemble the framework for technical analysis trading. It’s important to note that there is a key difference between the two.

  1. Markets are efficient with values that represent factors that influence a security’s price.
  2. Market price movements are not purely random. They move in identifiable patterns and trends that have a tendency to repeat themselves over time.

Underlying assumptions

The efficient market hypothesis (EMH) essentially means the market price of a security accurately reflects all available information. Therefore, it represents the true fair value of the security. This assumption derives from the idea that the market price is indicative of the total knowledge of all market participants. While many believe this assumption to be true, several elements can affect it. This includes news or announcements about a security that may have a short-term or long-term influence on a security’s price. In this sense, the technical analysis only works if markets are weakly efficient.

The second basic assumption underlying technical analysis leads to one core belief of technical analysts. That being market trends – both short-term and long-term – are identifiable. This enables market traders to profit from investing and draw from trend analysis.

Nowadays, technical analysis pulls its general groundwork from three principal assumptions.

Assumption #1: The market discounts everything

A majority of experts criticize technical analysis on the grounds that it only considers price movements and ignores fundamental factors. Technical analysts are of the belief that everything is already priced into the stock. This ranges from a company’s fundamentals to broad market factors to market psychology. This basically removes the need to acknowledge the factors separately before ultimately making an investment decision. The only thing that remains is the examination of price movements.

Technical analysts view this as the product of supply and demand for a specific stock existing in the market.

Assumption #2: The price moves in trends

Most – if not all – technical analysts believe that prices move in a short-term, medium-term, and long-term trend. In other words, a stock price is more likely to carry on a past trend than move unevenly. It’s important to note that most technical trading strategies draw their basis from this particular assumption.

Assumption #3: History has a tendency to repeat itself

Many technical analysts are of the belief that history is prone to repeating itself. It’s not uncommon to link the repetitive nature of price movements to market psychology. This in and of itself tends to be very predictable when one takes emotions (fear, excitement, etc.) into consideration.

Technical analysis utilizes chart patterns as a way to analyze these emotions and subsequent market movements. This way, they can better understand trends. While numerous forms of technical analysis have been in use for over 100 years, many believe that they are still relevant. This is because they illustrate patterns in price movements that, more often than not, repeat themselves.

The use of this method

Technical analysis makes an effort to forecast the price movement of virtually any tradable instrument. Moreover, an instrument that’s generally subject to forces of supply and demand. This includes stocks, bonds, futures, and currency pairs. As a matter of fact, some view technical analysis as simply the study of supply and demand forces. Specifically, those that draw from the market price movements of a security.

Technical analysis commonly applies to price changes. However, analysts track numbers other than just prices, such as trading volume and/or open interest figures.

Hundreds of patterns and signals exist across the industry. They are the product of years of research that aid in the support of technical analysis trading. Technical analysts have also made an array of trading systems to help determine and trade on price movements.

Some of these indicators focus primarily on identifying the current market trend, including support and resistance areas. Others mostly focus on determining the strength of a trend and the likelihood of its continuation. Commonplace technical indicators and charting patterns include such things as trendlines, channels, moving averages and momentum indicators.

Overall, technical analysts tend to look at the following broad types of indicators:

  • Price trends
  • Chart patterns
  • Indicators of volume and momentum
  • Oscillators
  • Moving Averages
  • Levels of support and resistance

Indicators for analysis and trading strategies

Indicators, such as moving averages, are tools that mathematically draw from technical analysis. Traders and investors alike use them to analyze the past, as well as predict future price trends and patterns. While fundamentalists will often track economic reports and annual reports, technical traders rely on indicators to help interpret the market.

The primary goal of using indicators is to identify trading opportunities. A moving average crossover, for instance, will often predict a trend change. For this, employing the moving average indicator to a price chart lets traders identify areas where the trend may change.

Conversely, strategies frequently make use of indicators in a more equitable manner. They use it to determine entry, exit and/or trade management rules. A strategy, to put simply, is a definitive set of rules. It indicates the exact conditions under which there’s an establishment, management, and closure of trades. Strategies typically include the use of indicators or – more regularly – multiple indicators to establish instances where the trading activity will ensue.

Indicators for trade

A gradual increase of technical indicators is widely available for traders to study. This includes those that are in the public domain, like a moving average or the stochastic oscillator. In addition, there are commercially available proprietary indicators. In addition, many traders develop their own unique indicators, sometimes with the assistance of a qualified programmer.

A good chunk of indicators have user-defined variables that allow traders to adapt key inputs, Such variables include the “look back period” (i.e. how much historical data there needs to be to form the calculations) to suit their needs.

Let’s look at a moving average as an example. This is simply an average of a security’s price over a specific period of time. This duration is specified in the type of moving average; for instance, a 50-day moving average. This moving average will equate the prior 50 days of price activity. This usually means incorporating the security’s closing price in its calculation. However, other price points – like the open, high or low – are also useful. The user outlines the length of the moving average and also the price point that will go into the calculation.

Strategies for trade

A strategy is a set of absolute rules that are objective and define when a trader will take action. Strategies will customarily include both trade filters and triggers, both of which often draw from indicators.

Trade filters recognize the conditions of the setup. Trade triggers identify when exactly a specific action should take place. For example, a trade filter might be a price that has come to a close above its 200-day moving average. This effectively sets the stage for the trade trigger. It is the actual condition that inevitably incites the trader to act. A trade trigger may be whenever the price reaches one tick above the bar that breaches the 200-day moving average.

Developing strategies

An indicator is, in fact, not a trading strategy. An indicator has the capability of helping traders identify market conditions. In a way, a strategy serves as a trader’s rulebook. There are a variety of different categories that exist for technical trading tools. These categories include trend, volume, volatility, and momentum indicators.

Traders will frequently use multiple indicators in order to form a strategy. However, when using more than one, people recommend that you use different types of indicators. Utilizing three different indicators of a similar type – like momentum – leads to multiple countings of the same information. A statistical term for this is ‘multicollinearity.’ The official definition of this particular term is, “…the occurrence of high intercorrelations among independent variables in a multiple regression model.”

You should avoid multicollinearity because it generates redundant results. Moreover, it can lead to other variables appearing less significant. Traders need to instead select indicators from different categories. For instance, a trader can select one momentum indicator and one trend indicator. Often times, one of the indicators is useful for confirmation. That is to say, confirming that another indicator is producing an accurate signal.

A moving average strategy might apply the use of a momentum indicator for confirmation that the trading signal is authentic. One momentum indicator is the RSI. This compares the average price change of advancing periods with the average price change of declining periods. As is the case with other technical indicators, the RSI has user-defined variable inputs. This includes determining what levels will indicate overbought and oversold conditions.

With this in mind, the RSI can confirm any signals that the moving average produces. Opposing signals may be indicative of the signal being less reliable and that you should avoid the trade.

Research requirement

Each indicator – and by extension, each indicator combination – requires research to determine the most suitable application. The act of choosing the application should take the trader’s style and risk tolerance into account. There is a notable advantage to calibrating trading rules into a strategy. That being it lets traders apply the strategy to historical data to evaluate the strategy’s past performance. This is a process known as ‘backtesting.’

Backtesting is the method for seeing just how well a strategy or model would do ex-post. It also evaluates the viability of a trading strategy by figuring out how it would play out using historical data. If backtesting ends up working, then traders and analysts may have the assurance to employ it going forward.

Be that as it may, this does not necessarily guarantee future results. However, it is capable of assisting in the development of a profitable trading strategy.

The differences between the analyses

As you may recall from the definitions earlier in the guide, these methods are on opposite ends of the spectrum. Both methods are especially useful for researching and forecasting future trends in stock prices. Similar to any other investment strategy or philosophy, they both have their fair share of supporters and opponents.

For the purpose of this section, let’s go over the functions of each analysis method again. This time, there will be more emphasis on defining fundamental analysis.

Fundamental analysis is a method of security evaluation that attempts to measure the intrinsic value of a stock. Fundamental analysts study just about anything that could potentially affect the value of a security. This includes everything from the overall economy and industry conditions to the financial condition and management of companies. Certain things like earnings, expenses, assets, and liabilities are all incredibly vital characteristics to fundamental analysts.

Any type of stock analysis attempts to identify whether a security is of correct value within a broader market construct. Fundamental analysis is typically done from a macro to micro perspective. Furthermore, it seeks to identify securities that are not of the correct price by the market. Investors can apply this information as a way to optimize the performance of their portfolio.

Technical analysis clearly differs from fundamental analysis in that the stock’s price and volume are the sole inputs. The core assumption is that the price takes all known fundamentals into account. For this reason, there is no real need to pay close attention to them. Technical analysts do not make any effort to measure a security’s intrinsic value. Instead, they use stock charts to identify patterns and trends that suggest what a stock will do later on.

Simple Moving Averages

Simple moving averages are indicators that help evaluate the stock’s trend by averaging the daily price over a certain period. The generation of buy and sell signals happens when a shorter duration moving average crosses a considerably longer duration.

Support and resistance frequently employ price history. Support is basically the areas where buyers have stepped in before. Resistance, on the other hand, consists of the areas where sellers obstruct price advances. Ultimately, standard practitioners will look to buy at support and sell at resistance.

At this point, we will define ‘trend lines’ due to their impending significance. These are lines drawn either over pivot highs or under pivot lows. This is to showcase the prevailing direction of price. Trend lines are a visual representation of support and resistance in any time frame. They illustrate the direction and speed of price, as well as describe patterns during periods of price contraction.

Trend lines are very similar to support and resistance because they provide definitive entry and exit points. In spite of this, they differ in that they are projections drawing from the stock’s past trades. They are regularly utilized for stocks that are moving to new highs or new lows. Generally, wherever there is no discernable price history.

Example of Trend Lines – Wikipedia

Support & Resistance

Let’s take a moment to provide some additional context for the terms ‘support’ and ‘resistance.’ These are concepts that are unquestionably two of the most prominent attributes of technical analysis. They play a notable role when it comes to analyzing chart patterns. Traders use them to refer to price levels on charts that are prone to acting as barriers. Thus, it prevents forcing the price of an asset in a certain direction.

Support is a price level in which a downtrend will likely pause due to a concentration of demand. As the price of a security continues to drop, demand for the shares gradually increases. Consequently, it actively forms the support line. At the same time, resistance zones emerge due largely in part to a sell-off when prices increase.

Once there is an identification of an area or “zone” of support or resistance, it provides valuable potential trade entry. Alternatively, it will provide exit points. Due to the price reaching a point of support or resistance, one of two things will happen until it hits the next support or resistance level:

  1. It will bounce back away from the support or resistance level, or
  2. It will violate the price level and continue in its direction

A majority of trade forms draw from the belief that support and resistance zones will not break. Whether the support or resistance level halts the price, or it breaks through, traders can “bet” on the direction. Moreover, they can quickly determine if they are correct or not. Should the price move in the wrong direction, a small loss can result in closing the position. However, if the price moves in the right direction, then the move may be ample.

Limitation #1 – EMH

As per usual with a majority of examination methods, there are some restraints that come with technical analysis. The most notable hurdle concerning the legitimacy of this particular method is the economic principle of the EMH. According to it, market prices reflect all current and past information already. Thus, there is no way to take advantage of patterns or mispricings in order to earn extra profits or alpha.

Economists and fundamental analysts who rely on efficient markets don’t believe that historical price and volume data contains actionable information. Moreover, they are of the belief that history doesn’t repeat itself; rather, prices move as a ‘random walk.’ This is a theory that alterations in stock prices have the same distribution. Additionally, they are independent of each other. Therefore, it assumes the past movement or trend of a stock price or market cannot predict its future movement.

This theory basically affirms that stocks take a random and unpredictable path. A path that makes all methods of predicting stock prices virtually fruitless in the long run.

Limitation #2 – Selective instances of working properly

A common additional criticism of technical analysis is that it works only in some cases. This is because it essentially aggregates something of a self-fulfilling prophecy. For instance, a lot of technical traders place a stop-loss order below the 200-day moving average of a certain company.

Let’s assume that a large number of traders have done so and the stock eventually reaches this price. Consequently, there will be a large number of sell orders, which will push the stock down. This will effectively confirm the movement that traders are expecting. Other traders will see the price decrease accordingly and also sell their positions, thus reinforcing the strength of the trend. Some will label this short-term selling pressure as self-fulfilling. Be that as it may, it will have little bearing on wherever the asset’s price will be in the future.

For the most part, if enough people use the same signals, they could cause the movement foretold by the signal. Nevertheless, this sole group of traders is not able to drive the price over the long run.

Using trend

A technique that’s extremely useful in technical analysis is ‘trend analysis.’ This method attempts to predict the future stock price movements drawing from recent trend data. Trend analysis derives from the idea that the actions of the past give traders an idea of future happenings.

There are three primary types of trends:

  1. Short-term
  2. Intermediate-term
  3. Long-term

Trend analysis aims to predict a trend, like a bull market run. In accordance with this, it will also ride that trend until data suggests a trend reversal, like a bull-to-bear market. Trend analysis is beneficial because moving with trends, not against them, will result in profits for an investor.

A standard trend is a general direction that the market is taking during a specific period of time. Trends can be both upward and downward; it ultimately relates to bullish and bearish markets, respectively. Admittedly, there is no definitive minimum amount of time that is a requirement for a direction to be a “trend.” Regardless, the longer the maintenance of direction, the more noteworthy the trend.

The core process of trend analysis is to try to look at current trends in order to predict future ones. It is seen by many as a form of comparative analysis. This can often include attempting to determine whether a current market trend – like gains in a particular market sector – is likely to continue. In addition, whether a trend in one market area could effectively result in a trend in another. Even though analysis may include a large amount of data, there is no assurance that the results will be accurate.

Examples of trend

So you want to begin analyzing applicable data? Well, it’s crucial that you first determine which market segment will be subject to examination. An example of sectors usually includes a focus on a particular industry, such as the automotive or pharmaceuticals sector. Moreover, a specific type of investment, such as the ‘bond market.’ This is a financial market in which issuance and debt security trading are both given to the participants.

As soon as there is a selection of the sector, it’s possible to analyze the general performance of the sector. This will often include how internal and external forces ultimately affect the sector. For example, alterations in a similar industry or the creation of a governmental regulation qualify as forces impacting the market. Analysts will take this data and make an effort to predict the direction the market will take when moving forward.

Following trends

A system that trend analysis uses is ‘trend following.’ It follows the recommendation that has been produced in order to figure out which investments to make. Most of the time, the execution of the analysis is via computer analysis and modeling of relevant data. Furthermore, it is in close relation to market momentum.

Strategies of trend trading

The average trend trader will try to isolate and extract profit from trends. There are an array of different trend trading strategies that use a variety of indicators:

  • Moving averages: These strategies consist of entering into long positions when a short-term moving average crosses over above a long-term moving average. In addition, entering short positions whenever a short-term moving average crosses below a long-term moving average.
  • Momentum indicators: These are strategies that involve entering into long positions when a security is trending with strong momentum. Moreover, exiting long positions whenever a security ends up losing momentum. More often than not, these strategies incorporate the relative strength index (RSI) in their operation.
  • Trend lines & Chart patterns: These strategies typically involve entering long positions whenever a security is trending higher, Likewise, they place a stop-loss below key trendline support levels. If the stock starts to reverse, then the trader will exit the position for a profit.

Indicators are capable of simplifying price information, as well as providing trend trade signals or warn of any reversals. Indicators are useful on all time frames and have variables that are adjustable to suit each trader’s specific preferences.

You can combine indicator strategies or come up with your own guidelines. This way, the establishment of entry and exit criteria for trades is made clear. Each indicator is greatly useful in various ways other than what’s been outlined. If you like a specific indicator, it is smart to research it further. Above all else, test it out before using it to make live trades.

Limitations of trend

Those who criticize trend analysis – and technical trading as a whole – argue that markets are efficient. Therefore, they already price in all of the available information. What this means is that history does not necessarily need to repeat itself. On top of that, the past does not forecast the future.

For example, supporters of fundamental analysis examine the financial condition of companies. They do this by using financial statements and economic models as a means to predict the future price. For these specific types of investors, day-to-day stock movements follow a random walk that cannot be patterns or trends. There is absolutely nothing that can result in them being interpreted as either one.

Volume’s significance

‘Trading volume’ (or ‘volume’) refers to the number of shares or contracts that indicates the activity of a security or market. Trading volume is an essential technical indicator that investors use to properly validate a trend or trend reversal. This volume provides investors with an idea of the price action of a security. Additionally, whether they should buy or sell the security.

Trading volume can aid in an investor’s identification of momentum in a stock and confirmation of a trend. Should trading volume increase, then prices will customarily move in the same direction. That is to say, if a security is continuing higher in an uptrend, the volume of the security should increase as well, and vice versa.

Let’s say, for example, a company increases in price by 10% during the previous month. An investor shows interest in the company and wishes to purchase a total of 1,000 shares. They conduct a fundamental analysis of the company. From this, they notice that its earnings and revenues have been consistently increasing over the past year. However, the investor is not too sure about the stock continuing in this uptrend and thinks it may reverse.

This is where trading volume analysis comes into play. The investor sees that there was a gradual and consistent increase in volume during the past month. In addition, they realize it was the highest volume the company has gone through during the past two years. Not only that, but the stock is continuing in the uptrend. This is indicative for the investor that the company is gaining momentum and the trend should continue higher. The increase in volume will result in the investor purchasing 1,000 shares of the company.

Volume & Low activity

Trading volume provides an additional function. It can indicate when exactly an investor should take profits and sell a security due to low activity. Let’s assume that there is no discernable relationship between the trading volume and the price of a security. This essentially signals weakness in the current trend, as well as a potential reversal.

Bringing back the company from earlier, imagine it extends its uptrend for another five months and increases by 70% in six months. The investor notices that share prices of the company are still in an uptrend. Furthermore, they continue to hold on to the shares. However, during the next few weeks, the stock continues in the uptrend and experiences a decrease in volume. This signals to the investor that the bullish uptrend in the company is beginning to lose momentum. It also indicates that it may end very soon.

During the following week, shares of the company decrease by 10% in one trading day. This is after being in an uptrend for up to six months. The stock breaks its uptrend, plus the volume is very high relative to its average daily trading volume (ADTV). The investor sells out of all the shares the following day because the reversal of trend was confirmed. This is primarily because of both the high volume and a decrease in price.

Forex

‘Forex analysis’ examines the changes that occur in the foreign exchange market (FX). In the forex, traders buy, sell, exchange, and hypothesize on currencies with the main objective of making a profit. The foreign exchange market – arguably the largest in the world – governs over $5 trillion in daily trading.

Banks, commercial companies, central banks, investment management firms, hedge funds, retail forex brokers, and traders utilize forex analysis. They employ it as a way to determine the best trade for a currency pair at any given time. Some forex analysis is manual, but for the most part, it is through the use of computers. Specifically, computers with software that analyzes historical data and signals from forex markets.

Traders frequently disagree about which type of analysis gets the best results. For new traders just entering into forex trading, the best method depends on how much time and information they have.

The forex market is highly liquid. The prices of currency pairs can change easily and drastically without any prior warning. One of the key benefits of trading currencies is its massive trading volume. This covers the most significant asset class globally.

Something important to note is that there is no one-stop shop for buying and selling currencies. Trading occurs through an array of individual dealers or financial centers through electronic networks. The forex market is open 24 hours a day, five days a week, and currencies are subject to worldwide trading among the major financial centers. These centers include London, Sydney, New York, Tokyo, and Singapore.

Forex analysis software includes charts that help identify user set perimeters. These may be available from a broker via the use of a trial account. It’s crucial that new traders experiment with a couple of different brokers and offerings before deciding where to open their account.

Forex types

Similar to how there’s no one-stop exchange for exchanging foreign currencies, there is also no one-stop type of forex analysis. Forex analysis is incredibly dependent on the business or individual that’s doing the trading. It also may be one of three types, the first two we have discussed at length in this guide: technical, fundamental, or based primarily on sentiment.

  1. Technical analysis: This is arguably the most popular type of forex analysis.
  2. Fundamental analysis: This relies heavily on current factors affecting countries’ economies. These particular traders look at analogous economic, financial, and other qualitative and quantitative factors.
  3. Sentiment analysis: This happens when a bulk of traders invest in a specific currency. It is basically the feeling or tone of either a market or its crowd psychology. When a trader uses sentiment to examine the forex market, they look for a large amount of investment in a specific currency. When a large number of investors purchase a given currency, the number of future sellers of that currency expands accordingly. This can result in the risk of many of those investors deciding to sell that currency simultaneously.

Types of charts

To provide context, swing trading is a style of trading. It tries to capture gains in a stock (or any financial instrument) over a period of time. This can range from a few days to several weeks. Swing traders primarily employ technical analysis as a way to seek out trading opportunities. These traders may also utilize fundamental analysis alongside examining price trends and patterns.

Swing charts are incredibly useful tools for technical analysis. Below are some of the primary reasons why this technique is so popular with this method of analysis:

  • Swing charts illustrate nothing but trends. This effectively simplifies the process of locating them. It’s important to remember that trends are the primary means to profit in pretty much any market.
  • Swing charts display less market ‘noise.’ This can help you more accurately apply other forms of technical analysis that are not as time sensitive.
  • There are several variations of this technique, including Kagi charts and Gann-based swing charts. They provide a more complex way to locate trends. These techniques also offer the option of conducting numerous empirical changes in order to further enhance trend-finding abilities.

The beginning of a swing construction

At their most rudimentary form, swing charts consist entirely of ‘price bars.’ These bars are representative of price behavior during a given time. Below is a bar chart (a chart that shows multiple price bars over time) that we’ll use as a reference:

A majority of technical traders have most likely come across a bar chart. This is due largely in part to it being the most common type of chart. The vertical lines are indicative of the price range. The peg on the left side is representative of the opening price. The peg on the right side represents the closing price during a given time period.

While there are different ways to construct a swing chart using highs and lows, we will focus on the Gann swing charting method. It is the most popular – and arguably the most effective – method out of the many others that exist. The four basic turning points in this type of chart are the following:

  • Up day: The higher high and the higher low (green).
  • Down day: The lower high and the lower low (red).
  • Inside day: The lower high and the high low (black).
  • Outside day: The higher high and the lower low (blue).

Addition of turning points

Here is the same bar chart, only this time it classifies every bar as one of the turning points:

Now that the beginnings and ends of several trends have been identified, we can move on to the next step. To properly construct the swing chart, we have to remove time as a factor. Instead, we must focus primarily on price action. In order to do this, we have to find two points:

  • Up day that a down day follows
  • Down day that an up day follows

These two points are indicative of when a trend begins or ends. As such, a time to either enter or exit a swing trade.

Now that these points have been marked, we can finally assemble the actual swing chart. First and foremost, we must eliminate the time factor. We do this by moving the points together in equal intervals; all while maintaining the order. After this, you simply connect all the points to fully complete the chart. The end product should look similar to this:

The usage of swing charts

Swing charts are useful for a variety of things:

  • They allow easy viewing of the overall trend of a market or equity. Trends are often discernable by simply looking for progressively higher highs and lows. Alternatively, by drawing trend lines.
  • They can easily position both ‘stop-loss’ and ‘take profit’ points. Preceding highs can be beneficial for take-profit points. Moreover, previous “step” bottoms throughout a trend are useful as moving stop-loss points.
  • Useful for applying technical analysis techniques that are not time sensitive. For instance, you are able to calculate Fibonacci levels. Alternatively, you can apply Elliott Waves. These can usually aid in predicting the direction at which the prices are going. They can also help you place more effective take-profit and stop-loss levels.
  • They lead to the creation of price channels. You can develop these by connecting consecutive highs and consecutive lows. This can assist in the prediction of prices, place moving take-profit and stop-loss points, or help conveniently liquidate or add to a position. Placing lines that link highs-highs, and another connecting lows-lows establishes a channel a price moves through.

Conclusion

There is certainly a lot that can be said about technical analysis if the length of this guide is anything to go by. While we have covered a lot of ground, there are still other components that make technical analysis what it is.

Overall, this method of analysis is as complex as it is prominent. Both it and fundamental analysis are their own entities and serve their own purposes in investments and trading.

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