I chose to read this book to expand my chart knowledge and learn more about the indicators used to make buying and selling decisions.
The goal in chart analysis is to determine which way price will move. Chart patterns can display who is in control of the price at a point in time and give clues as to what will happen next. Candlesticks are packets of information that tell about the strength of buyers and sellers. They display the open, the close, the high and the low for a specific period of time, and when analyzed in a group they can indicate pressure in the form of momentum, reversal, or stability.
Charts consist of three phases. Breakouts, trend reversals, and consolidations. The sequence and strength of these phases can vary greatly. Certain formations on the charts can be good indicators of these phases, such as the head and shoulders formation for example. The Chart forming a left shoulder, a head, and a right shoulder can be a signal for a trend reversal when confirmed by other signals such as the close of a candle that has broken a moving average or some other technical level. Support and resistance levels are levels that have been returned to multiple times and shown a reaction. These levels can be strong at first, but gradually weaken as the market repeatedly tests the level. This is called Order Absorption. The price will sometimes return to a support or resistance level more quickly before breaking it and continuing on the make a trend.
The more signals that occur at the same time, the less of a chance to fall into a trap. Late entries need to be avoided, and waiting for a candle to complete is an important discipline to focus on.
Indicators are mathematical, visual evaluations on the chart that can help determine possible coming phases of price action, entry and exit points, stops, and volatility. There are three groups of indicators; Momentum indicators, also known as oscillators, because they oscillate between defined higher and lower limits, Trend indicators, which analyze a prevailing trend, and Volatility indicators, which measure the extent to which the price fluctuates. Only one indicator per group should be used at a time to avoid getting redundant signals.
Moving averages are widely used trend indicators, and indicate an average price of a set group of candles. This is important because it shows whether the current price is above or below the average of the last X amount of candles.
Exponential Moving Averages give more weight to the last candle so they move faster than simple Moving Averages. Using one moving average over another is a matter of preference and the type of trading being done, but the idea is to use what other traders are using to be more effective at executing strategy. When many traders are gauging a reaction to price reaching or breaking past a moving average and making buy or sell decisions based on this event, it will affect what happens next in a more predictable manner.
The Relative Strength Index Indicator, or RSI, is a momentum tool that indicates the direction and strength of a price movement. It analyses the previous 14 candles on its default setting and compares average profit and loss. It also compares the candle sizes. It is a good tool for determining trend strength, and can be used to find reversals when there is a deviation in the RSI from price movement. If RSI comes down as price continues up, it is a strong indicator that momentum has come down and a reversal in price action is coming.
The Stochastic Indicator is another momentum tool like the RSI that shows where the close is relative to the absolute high or low of the previous X amount of candles. Since momentum always changes before price, if the stochastic shows the opposite of what is occurring on the chart, it can signal a reversal.
Bollinger Bands are a volatility indicator used for trend trading. It consists of a channel that encloses both sides of the candles, and widens as price moves up or down more strongly. In the center of the band is a moving average. If price shoots outside the band and closes there it is a strong indication of a trend that is likely to keep going. If the price closes back within the band it is a sign or rejection.
The Moving Average Convergence Divergence Indicator, or MACD, is a much used trend and momentum tool that gives trend change and confirmation signals when its moving averages come together or move apart. As the 12 and 26 ema’s move apart it means the trend is gaining strength because the current prices are rising faster than the past prices. If they come together a change in one way or another can be expected. The MACD can also show a divergence that signals a reversal.
There are many more indicators on the popular trading platforms than the ones explained in this book, but nobody uses all of them. The breakdown of these particular tools has been very helpful in my understanding of why they are used and how they work. Technical Analysis is just one part of trading, and being familiar with exactly what these visual representations show is happening in the market will help me make better decisions when trading.
