Technical analysis is the study historical prices, in an effort to determine the direction of future price action. Technical analysts, believe that all the current available information is incorporated into the price. Therefore, without new information, the only way to determine future price moves is to study historical prices patterns. There are several types methodologies used to analyze historical prices, including support and resistance, patterns and studies.
Support and Resistance
As prices move up and down, traders use technical analysis to attempt to find levels where there is demand and conversely levels were there is supply. Support describes demand, as it is a level where prices have a difficult time moving lower. Support could be a weekly low, or a moving average or even a trend line.
A moving average is the average of a specific period. For example, the 10-day moving average averages the past 10-days and on the eleventh day, the first day is dropped from the calculation. A trend line can be upward sloping, downward sloping or horizontal. Generally, support is created from either an upward sloping trend line that connects two or more lows, or a horizontal trend line.
Resistance is a level that is described as supply. Here prices have a difficult time moving higher because investors are taking profit, or shorting/selling a currency pair. A weekly or daily high, along with a trend line or moving average can describe levels of resistance. Support and resistance levels can assist in terms of helping you either enter or exit a trade.
For example, if the price of crude oil broke through the upward sloping trend line, you might decision to short oil. You also might decide to sell oil if prices rose back to the 10-day moving average which many investors might use as resistance.
Many trades also like to use patterns to determine the future direction of a market. Most traders focus on either reversal patterns or continuation patterns. A reversal pattern, is one where prices form either a top or a bottom. For example, the head and shoulder pattern, takes on the shape of a human head and shoulder. This usually comes at the end of an uptrend, and when the neckline is broken prices tumble. There is also a reverse head and shoulder pattern which comes at the end of a downtrend and generally signals that prices are ready to move higher.
A continuation pattern is a pause that usually refreshes. An example of a continuation pattern is a bull or bear flag. For a bull flag, prices break higher and then consolidate edging lower forming a flag pattern, before they break higher again. The bear flag is similar but prices move lower consolidate and then refresh lower.
There are many types of studies that are also used. Moving average studies are some of the more popular studies. For traders who are looking for a trend following study, the moving average crossover is one of the more popular studies. Here a buy signal is created when a short term moving average crosses above a long term moving average. A sell study generates a signal when the short term moving average crosses below a long term moving average.
By using technical analysis you can combine support and resistance, along with patterns and studies to help you find specific points to initiate risk.