The basics of technical analysis

Technical analysis is a technique used to spot potential trading opportunities through the interpretation of chart patterns and indicators on price charts. Although this sounds like a complex and difficult skill to master, many technical signals are easy to see on price charts and many of these offer a very reliable prediction of future price movements. Technical analysts can therefore base their trades on an expectation of where price should move once these patterns have been formed. Along with chart patterns, technical traders also use indicators in order to reinforce their trading decisions. Indicators are applied to price charts and can provide another visual representation of data which provides foresight of where price will be heading in the future.

Technical chart patterns

Technical chart patterns are formed by movements in price which, historically, have been seen to signal the future direction of price. These patterns come in many forms, but the most popular of these are also the most reliable and can allow binary options traders to take a potentially profitable position and to close positions which may be counter to these patterns. One of the main reasons why these patterns are so reliable is the simple fact that almost all traders are aware of their significance when they occur. The patterns therefore become self-fulfilling and this enhances the probability that price will move in the expected direction as traders take positions in anticipation of this.

Double tops

Although there are several important patterns that all technical traders need to be able to spot, one of the easiest and most important of these are the ‘double top ’and ‘double bottom’ chart patterns. This is formed when price moves to a new high or low before correcting to form a higher low or lower high on the pullback. The price then moves again in the direction of the new high or low but fails to reach this before correcting again. This pattern shows that the market trend is reversing and the pattern created shows a good opportunity for profitable trading. The reliability of this pattern is based on both the market exhaustion for the new high and also the fact that traders see this as a change in sentiment and a significant correction or even a change in trend.

Head and shoulders

These patterns can take some time to perform but are seen as one of the most reliable, and memorable, trading patterns. This is formed by price moving to a new high, correcting and pushing to an even higher high. Price then corrects and returns to the low of the previous correction before trying to move up again but without making a new high. After this price movement a pattern is formed which looks like a head and shoulders. This is a high-probability reversal pattern and traders look for price to drop below the ‘neckline’ off the right-hand shoulder.

Indicators

There are literally thousands of indicators available, many of which have been designed by individual traders and applied to charting packages such as Metatrader. As with chart patterns, there are several technical indicators which are provided by most trading platforms and are considered the most reliable by traders. These indicators are divided in to groups of momentum and trend indicators. The most popular trend indicators are ‘moving averages’ which produce a line on the chart representing the average price over a period of time. More than one of these can be applied to charts with different settings and provide entry signals to traders when these crossover and a new trend direction is established. Momentum indicators, such as stochastic oscillators, show traders how much energy the market has at any particular price. When the stochastic oscillator has a high, or overbought, reading traders may avoid taking long positions and look for signals of a future price correction or reversal.


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