Technical Analysis and Indicators

eur:usdMost spread bettors such as scalp traders, day traders, swing traders and position traders will rely on technical analysis and indicators to predict market movements and price reversals in order to make profitable trades.

In order to help new spread bettors I’ve put together a succinct (and readable) guide to explain all of the main technical indicators, how they work and how you can combine them with your trading.  In addition to an explanation of how they work, I’ve also tried to outline the advantages and disadvantages of each of the indicators below.

Technical Analysis and Indicators:

 

What is Technical Analysis?

Unlike fundamental analysis, which relies on concrete economic data such as the latest government’s latest unemployment figures or foreign exchange rates to open trades, technical analysis involves analysing stock prices and predicting future patterns based on the historic data and the current buy/sell volume of trades.

The history of technical analysis dates back to the 17th century in Joseph de la Vega’s accounts of the Dutch Markets.  Since then, a number of books have been published and a vast range of technical indicators developed to meet certain needs   Technical indicators such as Bollinger Bands, MACD, RSI, and Stochastic Oscillators are the most commonly used tools in technical analysis and were mostly developed in the 1950s-1980s.

A couple of the most seminal books in technical analysis includes Stock Market Theory and Practice and Technical Market Analysis (Charles Dow and William Hamilton) and Technical Analysis of Stock Trends (Robert Edwards and John Mageem 1948).

Technical analysis often revolves around the psychology of investors (behavioural economics) which is why psychological/emotional analysis and technical analysis are often considered under the same category.  When you’re using an indicator such as Bollinger Bands or momentum oscillators such as the Average Directional Index (ADX) you’re basically playing on buyers/sellers opinions rather than occurrences in the underlying markets themselves.  For example, swing traders that place stop-losses and limit orders at the resistance and support levels are essentially hoping that buyers/sellers will re-affirm stocks at these levels and prevent break-outs from occurring.

Since the 19th century, a number of technical indicators have been developed to help analyse certain characteristics in the stock markets, ranging from Bollinger Bands (which help to identify market volatility and support/resistance levels) to Average Directional Index (measures the strength of market trends) and RSI (measures whether a market is overbought or oversold).

Although none of the technical indicators above are perfect for predicting emerging trends in the markets (efficient-market hypothesis states that the stock markets are unpredictable anyway), they can be used in concatenation with one another find reliable trends, support and price directions in the markets.  Some technical indicators are also only relevant to specific markets, for example, the RSI and ADI (developed in Wilder’s New Concepts in Technical Trading Systems) were  developed for the technical analysis of commodities and securities markets and might not be so useful for underpinning movements in the stock markets such as the FTSE and S&P.

 

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