Chart Analysis Basics

The science of identifying the optimum moments of buying and selling is known as “Technical Analysis” which is also known as “Chart Analysis”. “Technical Analysis” is a science. It means it is governed by clear and rigid laws. We will use computer to plot the price charts, and we will learn to draw some lines on them. These lines help us determine what will happen to price in the future. They also give us an insight into how long price will remain above or below these lines.

Different Types of Price Chart:

1. Tick Chart

The simplest price chart is a “tick chart”. On the tick chart, each new change in the prices is charted by standard move across the chart. The chart takes no account of time. So the more times the price changes, the more moves are made across the chart. Tick charts are not used in technical analysis.

2. Bar chart

If you look at the price changes that can happen during a day, you will see how the price changes can be shown on a vertical line which is called bar. Every day, the price opens at a certain level, and finally at the end of the day, it closes at a certain level. There is also a high and a low price for each day. All of these four prices can be shown on a vertical line which is called bar.

3. Candlestick Chart

Candlesticks have exactly the same system as the bars. Just they have a different appearance. Candlesticks are very important indicators that can be used in locating the best buy and sell signals. The candlestick body can change color.

If the close price is higher than open, the candlestick is called “bullish candlestick” and it can be shown with a white or green color. If the close price is lower than the open price, the candlestick is called “bearish candlestick” and it can be shown with a black or red color. Many traders find the candlestick more visually appealing and easier to interpret. With an uptrend, the chart whitens. With a downtrend, the chart on the contrary darkens.

Trend:

We will talk about the trends in more details later. A trend is the direction the market is moving in. If each subsequent peak is above the previous one, we have an “uptrend”. If each subsequent peak is lower than the preceding one, we have a “downtrend”. If the peaks and valleys are at the same level, it is a “range”.

Price can move in three directions: Up, Down, Sideways

If the market is trending up, it is time to buy. If it is down, sell. If the market is ranging, you’d better to do nothing.

Renko chart eliminates the noise and makes the chart much simpler. If you like to have a simpler chart which has less noise, you can use Renko.

Support and Resistance:

The last local minimum is known as a support level. A horizontal line drawn through the last price peak is known as the resistance level. When the price breaks above a resistance level, the broken resistance level will change to a support level. Similarly, when the price breaks below a support level, the broken support level will change to a resistance level.

To plot a support line on an uptrend, you just need to connect the most visible lows. To plot a resistance line on a downtrend, you just need to connect the most visible highs.

When you are in an uptrend what you do is buying at the support line. You can sell when the uptrend support line is broken.

When you are in a downtrend, you can sell at the resistance line. You can buy when the downtrend resistance line is broken.

In our videos we have continued the chart analysis discussion. Here is the topics covered in our videos:

• Reversal Patterns:
  – Head and Shoulders
• Continuations Patterns:
  – Wedge
  – Raising Wedges
  – Falling Wedges
  – Triangles
  – Symmetrical
  – Ascending
  – Descending
  – Flags (Rectangle)

In our videos we have continued the chart analysis discussion. In our videos is focused on “Indicators”. Here is the topics covered in our videos:

Indicators are used extensively in technical analysis to predict changes in trends or price patterns. In the context of technical analysis, an indicator is a mathematical calculation based on a securities price and/or volume. The result is used to predict future prices.

Moving Average:

“Simple Moving Average” or “SMA” is the simplest indicator. SMA is plotted based on the average of the close price. “n”, is the period. For example, when “n” is set to 14, then the average of 14 close prices will be calculated to plot a point on the chart.

You can use several moving averages on the chart. For example, here (watch our videos) we have two moving averages. The red one is set to 14 and the blue one is set to 28.

“Moving Average” is a trend indicator. When the price is above the moving average, it is an uptrend. When the price is below the moving average, it is a downtrend.

MACD:

Moving Average Divergence Convergence or MACD is another famous indicator. MACD is a trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26 and 12 moving averages.

MACD is a great indicator to distinguish the trend reversals. In an uptrend, when the price is going up and MACD is going down, it indicates that the trend reversal is so close and the trend will reverse soon. This is called “Divergence”.

Similarly, in a downtrend, when the price is going down and MACD is going up, it indicates that the downtrend reversal is so close and the trend will reverse soon.

This is called “Convergence”.

Stochastic:

“Stochastic” is another famous indicator. “Stochastic” is a price oscillator. This indicator has a relatively complicated formula. Therefore, to keep it simpler, we will forget about the formula, and instead we will show you how this indicator works on the price chart. You can use different settings of Stochastic. The default setting is 14 7 3. However, you can make it faster if you set it to 5 3 3.

This indicator can not be used alone to locate the trade setups. It has to be used with the other indicators like MACD, and also technical analysis as confirmation. We will tell you how to use this indicator to trade shortly.

RSI:

“Relative Strength Index” or “RSI” is one of the other famous indicators. This indicator has great features and it can be used alone to locate the trade setups.

However, using this indicator with technical analysis helps you locate stronger trade setups. We will tell you how to use RSI to trade and make money.

“Moving Average” is a good indicator. However, it works only when the market trends. When the price is at the beginning of a sideways movement, moving average starts generating false signals. You will find out that you are at the beginning of the sideways markets, only after losing in some trades. We are not recommending you not to use the moving average indicator in your charts. You can still use them, to stay at the safe side, it is recommended to take the advantage of the other indicators, as well as technical analysis.

On this chart (watch our videos), we have all the indicators we talked about so far:

1. Moving Average 12 and 26
2. RSI
3. Stochastic
4. MACD

Let’s see how these indicators locate the trade setups for us. Then, to keep it simpler, we will get rid of the ones that are not necessary to be on the chart. We start with long trade setups or buy signals.

This is a long trade setup. It is formed after a resistance breakout here:

“Resistance Breakout” occurs when one of the candlesticks closes above the resistance. This “Resistance Breakout” is enough for us to go long. However, we use the indicators to have more confirmation. Indicators are good to help us have a more confirmed trade setup. Let’s see how our indicators confirm the “Resistance Breakout”.

When there is a resistance breakout, RSI should be already going up. It should be above the 50 level. As you see, RSI has been going up before the resistance breakout and, was above the 50 level when the resistance breakout occurred. So, our resistance breakout is confirmed by RSI.

Similarly, to confirm the resistance breakout, Stochastic should also be going up and above the 50 level. In this case, Stochastic is also confirming the resistance breakout. In case of resistance breakout, MACD should also be going up. However, as MACD is a delayed indicator, usually it is not above the zero level when the resistance breakout occurs. In this example, MACD also confirms the resistance breakout. As you see, it has been going up long time before the resistance breakout, and it was so close to the zero level when the resistance breakout occurred.

There is another important signal formed by MACD.

“MACD Convergence” which is a very strong reversal signal. Having “MACD Convergence” right before the resistance breakout is a big confirmation. As moving averages are delayed, they were not at the right position when the resistance breakout occurred. So we ignore them in this example. In spite of this, all of the other indicators confirm the resistance breakout. Now the question is when we should have entered the market.

We could buy at the close of the candlestick that closed above the resistance. The stop loss had to be set several pips below the candle that closed above the resistance.
The target or take profit level can be at least 3 times bigger than the stop loss size. In this example, as our stop loss is about 220 pips, the target can be about 660 pips.

This is how our indicators work. To make it simpler, we remove the moving averages. All we have to wait for is support or resistance breakout which is confirmed by RSI, Stochastic, and MACD.

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