Learn Trading: Basics of Technical Analysis

Traders are constantly searching for different trading systems,
refreshing
ideas, and new innovations to better refine their trading plans. By
investigating the works of the forefathers of technical analysis,
Traders can
gain an immense knowledge of the workings of the financial markets.
Technical
analysis is based on three basic premises. First, the market is a
discounting
mechanism, which means that every fact or information pertaining to the
market
is already been discounted in the price since there are individuals and
groups
with large interests and pockets, who are armed with the latest
research and
findings, and who can afford to stay on top of the latest developments
in the
market. Second, technical analysis involves the study of mass
psychology and
the repetition of price patterns or formations. Since crowds behave
similarly,
price patterns will repeat again and again. Third, markets are either
consolidating or trending. When the market is trending, the odds are
that the
market will continue to trend.

The forefathers of technical analysis wrote extensively about technical
set
ups relating to the markets and noted their own observation pertaining
to the
mental and psychological aspects of trading as well. Having the trading
plan
and technical set ups account for nearly ten percent of your success as
a trader.
Your ability to make timely trade executions and to stay head and
shoulders
above the crowd accounts for about 90 percent of your success as a
trader.
Charles Dow, a prolific author and a journalist pioneered the art of
technical
analysis. He wrote his own observations in a series of editorials and
articles
in the Wall Street Journal around 1901-1903. Robert Rhea, William
Hamilton,
and Samuel A. Nelson compiled and formalized Dow work into a body of
theories.
Each of these authors wrote books in his turn. Samuel Nilson wrote ABC
of stock
speculation. For example, among the basic tenets of the Dow Theory is
that there
will always be three different price fluctuations in the market. The
primary,
the secondary, and the minor trend, which is respectively synonymous to
saying
daily, weekly, and yearly fluctuations. Successful traders include more
than
one time frame in their analyses to have a full picture of the whole
structure
of the market. The hourly chart can be used in conjunction with the
daily chart.
The daily chart can be used in conjunction with the weekly chart.

Equally, Charles Baucker, Richard Wyckoff, Ralph Nelson Elliott made
significant contributions to the art of technical analysis. Richard
Schabacker,
The father of the art of technical analysis in principle, pioneered the
concept
of chart patterns. He introduced terms such as head and shoulders,
triangles,
flags. He is also the first individual to use trendlines to define
support and
resistance levels. Richard Wyckoff coined the concept of testing, and
examined
meticulously market actions and reactions. He observed and looked for
nuances
in chart patterns to analyze how a specific price pattern may emerge.
For
instance, he looked at how the market shook bulls (buyers) before a
major rally.
Elliott is credited with the concept of waves and that, not only
charts, but
also waves form patterns, which will repeat themselves again and again.
For
instance, he introduced the concept of impulse wave which tend to
happen in
the direction of the trend.

MOMENTUM INDICATORS

Momentum indicators, also called oscillators, are used in technical
analysis
to measure the velocity of price changes (momentum) both up and down.
Every
momentum indicator is an oscillator as it oscillates between two
extreme levels.
These extremes are commonly known as overbought and oversold levels.
When an
oscillator reaches the upper extreme level, it is said to be
overbought. When
an oscillator reaches the lower extreme level, this condition is known
as
oversold. The horizontal line in between these extremes is referred to
as the
equilibrium line. The Relative Strength Index (RSI), the moving average

convergence/divergence (MACD), and the stochastic index are widely used

momentum indicators.

RELATIVE STRENGTH INDEX (RSI)

Momentum oscillator developed by J.Welles Wilder in the late 1970s and
discussed in his book, New Concepts in Technical Trading Systems. RSI
measures
the relative strength of the present price movement as increasing from
0 to
100. There are many variations of RSI in use today although Wilder
emphasized
using a 14 period and setting the significant levels of RSI at 30 for
oversold
(signaling upturn) and 70 for overbought (signaling downturn). The
averages
of up days and down days for 14 day periods are plotted. If the
financial
instrument makes a new high but the RSI does not move beyond its
previous high,
this divergence suggests reversal. When RSI bounces down and falls
below its
most recent trough that signals a price reversal.

STOCHASTIC INDEX

Oscillator which measures overbought and oversold conditions in a
financial
instrument based on moving averages and relative strength concepts. In
its
simplest form, the stochastic index is expressed as a percentage of the

difference between the low and the high price of a financial instrument
during
the stochastic chosen period. For instance, if the stochastic period is
14days
and the high in that period was 50 and the low 40, the difference would
be 10.
If the price at the time of the calculation of the stochastic index was
40,
the stochastic reading would zero. At a price of 50, the stochastic
would be
100. At 45, the stochastic would be 50. The stochastic index normally
plots
a 5 day moving average of the stochastic. Lines representing the 25
percent
and 75 percent levels refer to oversold and overbought conditions
respectively.
If the stochastic index falls below the 25 percent line, that suggests
an
oversold condition. When the stochastic index rises above the 75
percent line
that indicates an overbought condition. An upward reversal through the
25
percent line is a positive breakout and a downward reversal through the
75
percent line is a negative breakout, indicating new uptrend and
downtrends
respectively.

MOVING AVERAGE CONVERGENCE/DIVERGENCE (MACD)

Oscillator developed by Gerald Appel which measures overbought and
oversold
conditions. MACD, pronounced MACD, makes use of three exponential
moving
averages a short one, a long one, and a third, which is the moving
average of
the difference between the other two and represents a signal line on
the MACD
graph. (MACD is typically shown as a histogram, which plots the
difference
between the signal line and the MACD line. Trend reversals are signaled
by the
convergence and divergence of these moving averages. When the histogram
crosses
the zero line upward, that suggests a positive breakout (a buy signal).
If the
histogram crosses the zero (equilibrium line downward (a sell signal),
that
indicates a negative breakout. One of the most popular MACD indicators
in use
is the 8/17/9 MACD. On a daily MACD, the short moving average would be
8 days,
the long one 17 days, and signal line 9 days. On a weekly MACD, the
same applies
but those same numbers would refer to weeks rather than days.

MY FOREX TRADING SYSTEM

I have been trading the fx market for 3 months now started out with 5min-15min, 1hr-4hr charts and i feel more comfortable trading with 1hr and 4hr charts i use 1hr charts to identify my entry and exit positions.. The best method of trading the fx market is developing a system that suits your personality basically i like to trade with as much as 60-120 pips daily and stopls of 30-50 pips on each currency pair that i trade..usd/jpy wave analysismy wave counts on my monthly charts began at 01/01/2005 and is currently in progress with resistances at 120.80, 128.50and 140.70 on weekly basis a 5 wave pattern is also underway that began at 14/05/2007 with major resistances at 121.15, 125.36 and 132.00 .. on daily basis which i use in defining entry and exit points. the pair is in an a,b,c corrective pattern which seems to be almost complete with major support holding at 120.80 and then the final 119.60 clearly buying at 119.60-70 with stops of 30 pips is a very huge bargain wih targets as much as 125.36 which will complete wave 3 on weekly basis..Gbp/ jpy Wave AnalysisOn my monthly charts gbp/jpy began a 5 wave pattern from 01/09/2000 and seems to be in a 5 wave pattern which now seems to be in wave 3 fibonacci expansions fromat 152.84 ,192.43 and 179.11 gives 161.8% at 251.00 resistance which currently prices have failed to breach...Down to my weekly analysis a 5 wave pattern that began at 16/01/2005 is currently at either wave 5 or 3 which seems to be complete..On my daily charts a 5 wave pattern is complete and i see a formation of an ending diagonal which might have been complete after prices failed to take out 251.00 seriously.. If my waves count are correct and prices drop below 246.00 ending diagonal support that would be a very strong signal to go short on gj with support levels at s1-243.90 s2-239.66 s3-235.99 and finally if the downtrend is too strong s5 at which as elliot said will signal the end of the correction at minor wave 4.. Trade wisely and always trade with stop losses...Eur/Usd wave AnalysisThere is no doubt that over the last month the dollar has been in so much trouble those that entered long on this pair are probably between a 200-500 pip gain but for how long can this uptrend continue? On weekly basis fibonacci extensions of 100% at 1.3815 is were prices are were prices are ranging at but with the present overbought conditions the momentum might be just dying out soon but upside risks still hold with trend line resistance at 1.3888 .. presently in wave forms it is currently in a wave 3 in weekly basis... On daily basis it is in wave 3 or 5 which is currently in progress if the trend line reistance of 1.3870 is taking out then a move to as far as 1.3967 will be in view which is 100% fibonacci extension of the move from 13/06/07 , 05/07/07 and 06/07/07... on daily charts.....Trade well Trade wisely and Trade with stop losses...!!!Lastly Gbp/usd wave analysisWell with wave patterns similar to that of Eur/Usd pair the pair is in overbought conditions with upside risks still feasible due to the weak dollar!! perception... In wave form presently wave 3 in weekly charts which as elliot said is the longest of the 5 wave patterns so upside momentum could just continue.. Weekly trend lines point at 2.0651 which could be breached!! On daily wave count it is now in wave 3 or 5 in wave pattern sequence with fibonacci extension of 100% of the move from 06/07/07, 04/07/04 and 06/07/07 at the price of 2.0637... I would strongly be watching 2.0640-2.0650 closely and anticipating a reversal at such position but if breached a continuation is expected towards 2.0740 which i seriously doubt would happen due to overbought conditions on weekly basis but we can never tell... Trade well Trade wisely and always trade with stop losses..!!