e MACD line is the difference between two exponential moving averages and the signal or trigger line, which is an exponential moving average of the difference. If the MACD and trigger lines cross, then this is taken as a signal thaTechnical Analysis can be divided into five major categories:
- Price indicators (oscillators, e.g.: Relative Strength Index (RSI))
- Number theory (Fibonacci numbers, Gann numbers)
- Waves (Elliott’s wave theory)
- Gaps (high-low, open-closing)
- Trends (following moving average).
[a] Price indicators
Relative Strength Index (RSI): The RSI measures the ratio of up-moves to down-moves and normalizes the calculation, so that the index is expressed in a range of 0-100. If the RSI is 70 or greater, then the instrument is assumed to be overbought (a situation in which prices have risen more than market expectations). An RSI of 30 or less is taken as a signal that the instrument may be oversold (a situation in which prices have fallen more than the market expectations).
Stochastic oscillator: This is used to indicate overbought/oversold conditions on a scale of 0-100%. The indicator is based on the observation that in a strong up-trend, period closing prices tend to concentrate in the higher part of the period’s range. Conversely, as prices fall in a strong down-trend, closing prices tend to be near the extreme low of the period range. Stochastic calculations produce two lines, %K and %D, that are used to indicate overbought/oversold areas of a chart. Divergence between the stochastic lines and the price action of the underlying instrument gives a powerful trading signal.
Moving Average Convergence/Divergence (MACD): This indicator involves plotting two momentum lines. Tht a change in the trend is likely.
[b] Number theory:
Fibonacci numbers: The Fibonacci number sequence (1, 1, 2, 3, 5, 8, 13, 21, 34 …) is constructed by adding the first two numbers to arrive at the third. The ratio of any number to the next larger number is 61.8%, which is a popular Fibonacci retracement number. The inverse of 61.8%, which is 38.2%,
Elliott’s wave theory: The Elliott Wave Theory is an approach to market analysis that is based on repetitive wave patterns and the Fibonacci number sequence. An ideal Elliott wave pattern shows a five-wave advance followed by a three-wave decline is also used as a Fibonacci retracement number (as well as extensions of that ratio, 161.8%, 261.8%). Wave patterns and behavior, identified in Forex trading, correlate (to some extent) with relations within the Fibonacci series. The tool is used in technical analysis that combines various numbers of Fibonacci retracements, all of which are drawn from different highs and lows. Fibonacci clusters are indicators which are usually found on the side of a price chart and look like a series of horizontal bars with various degrees of shading. Each retracement level that overlaps with another, makes the horizontal bar on the side darker at that price level. The most significant levels of support and resistance are found where the Fibonacci cluster is the darkest. This tool helps gauging the relative strength of the support or resistance of various price levels in one quick glance. Traders often pay close attention to the volume around the identified levels to confirm the strength of the support/resistance.
Gann numbers: W.D. Gann was a stock and a commodity trader working in the ’50s, who reputedly made over $50 million in the markets. He made his fortune using methods that he developed for trading instruments based on relationships between price movement and time, known as time/price equivalents. There is no easy explanation for Gann’s methods, but in essence he used angles in charts to determine support and resistance areas, and to predict the times of future trend changes. He also used lines in charts to predict support and resistance areas.
[c] Waves.
[d] Gaps
Gaps are spaces left on the bar chart where no trading has taken place. Gaps can be created by factors such as regular buying or selling pressure, earnings announcements, a change in an analyst’s outlook or any other type of news release.
An up gap is formed when the lowest price on a trading day is higher than the highest high of the previous day. A down gap is formed when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a sign of market strength, while a down gap is a sign of market weakness. A breakaway gap is a price gap that forms on the completion of an important price pattern. It usually signals the beginning of an important price move. A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For that reason, it is also called a measuring gap. An exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.
[e] Trends
A trend refers to the direction of prices. Rising peaks and troughs constitute an up trend; falling peaks and troughs constitute a downtrend that determines the steepness of the current trend. The breaking of a trend line usually signals a trend reversal. Horizontal peaks and troughs characterize a trading range.
In general, Charles Dow categorized trends into 3 categories: (a) Bull trend (up-trend: a series of highs and lows, where each high is higher than the previous one); (b) Bear trend (down-trend: a series of highs and lows, where each low is lower than the previous one); (c) Treading trend (horizontal-trend: a series of highs and lows, where peaks and lows are around the same as the previous peaks and lows).
Moving averages are used to smooth price information in order to confirm trends and support-and-resistance levels. They are also useful in deciding on a trading strategy, particularly in futures trading or a market with a strong up or down trend. Recognizing a trend may be done using standard deviation, which is a measure of volatility. Bollinger Bands, for example, illustrate trends with this approach. When the markets become more volatile, the
bands widen (move further away from the average), while during less volatile periods, the bands contract (move closer to the average).
Various Trend lines
Pattern recognition in Trend lines, which detect and draw the following patterns: ascending; descending; symmetrically & extended triangles; wedges; trend channels.
GO 2:
1 – Technical Analysis: background, advantages, disadvantages
2 - Various techniques and terms
