Technical Analysis: Introduction

The methods used to analyze securities and make investment decisions fall into
two very broad categories: fundamental analysis and technical analysis.
Fundamental analysis involves analyzing the characteristics of a company in order
to estimate its value. Technical analysis takes a completely different approach; it
doesn't care one bit about the "value" of a company or a commodity. Technicians
(sometimes called chartists) are only interested in the price movements in the
market.

Despite all the fancy and exotic tools it employs, technical analysis really just
studies supply and demand in a market in an attempt to determine what direction,
or trend, will continue in the future. In other words, technical analysis attempts to
understand the emotions in the market by studying the market itself, as opposed to
its components. If you understand the benefits and limitations of technical analysis,
it can give you a new set of tools or skills
that will enable you to be a better trader or investor.

In this tutorial, we'll introduce you to the subject of technical analysis. It's a broad
topic, so we'll just cover the basics, providing you with the foundation you'll need to
understand more advanced concepts down the road.

Technical Analysis: The Basic Assumptions

What Is Technical Analysis?
Technical analysis is a method of evaluating securities by analyzing the statistics
generated by market activity, such as past prices and volume. Technical analysts
do not attempt to measure a security's intrinsic value, but instead use charts and
other tools to identify patterns that can suggest future activity.
Just as there are many investment styles on the fundamental side, there are also
many different types of technical traders. Some rely on chart patterns, others use
technical indicators and oscillators, and most use some combination of the two. In
any case, technical analysts' exclusive use of historical price and volume data is
what separates them from their fundamental counterparts. Unlike fundamental
analysts, technical analysts don't care whether a stock is undervalued - the only
thing that matters is a security's past trading data and what information this data
can provide about where the security might
move in the future.

The field of technical analysis is based on three assumptions:

1. The market discounts everything.

2. Price moves in trends.
3. History tends to repeat itself.

1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement,
ignoring the fundamental factors of the company. However, technical analysis
assumes that, at any given time, a stock's price reflects everything that has or
could affect the company - including fundamental factors. Technical analysts
believe that the company's fundamentals, along with broader economic factors and
market psychology, are all priced into the stock, removing the need to actually
consider these factors separately. This only leaves the analysis of price
movement, which technical theory views as a product of the supply and demand
for a particular stock in the market.

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means
that after a trend has been established, the future price movement is more likely to
be in the same direction as the trend than to be against it. Most technical trading
strategies are based on this assumption.
3. History Tends To Repeat Itself
Another important idea in technical analysis is that history tends to repeat itself,
mainly in terms of price movement. The repetitive nature of price movements is
attributed to market psychology; in other words, market participants tend to provide
a consistent reaction to similar market stimuli over time. Technical analysis uses
chart patterns to analyze market movements and understand trends. Although
many of these charts have been used for more than 100 years, they are still
believed to be relevant because they illustrate patterns in price movements that
often repeat themselves.

Not Just for Stocks

Technical analysis can be used on any security with historical trading data. This
includes stocks, futures and commodities, fixed-income securities, forex, etc. In
this tutorial, we'll usually analyze stocks in our examples, but keep in mind that
these concepts can be applied to any type of security. In fact, technical analysis is
more frequently associated with commodities and forex, where the participants are
predominantly traders.

Now that you understand the philosophy behind technical analysis, we'll get into
explaining how it really works. One of the best ways to understand what technical
analysis is (and is not) is to compare it to fundamental analysis. We'll do this in the
next section.

Technical Analysis: Fundamental Vs.

Technical Analysis
Technical analysis and fundamental analysis are the two main schools of thought
in the financial markets. As we've mentioned, technical analysis looks at the price
movement of a security and uses this data to predict its future price movements.
Fundamental analysis, on the other hand, looks at economic factors, known as
fundamentals. Let's get into the details of how these two approaches differ, the
criticisms against technical analysis and how technical and fundamental analysis
can be used together to analyze securities.
The Differences
Charts vs. Financial Statements
At the most basic level, a technical analyst approaches a security from the charts,
while a fundamental analyst starts with the financial statements. (For further
reading, see Introduction To Fundamental Analysis and Advanced Financial
Statement Analysis.)

By looking at the balance sheet, cash flow statement and income statement, a
fundamental analyst tries to determine a company's value. In financial terms, an
analyst attempts to measure a company's intrinsic value. In this approach,
investment decisions are fairly easy to make - if the price of a stock trades below
its intrinsic value, it's a good investment. Although this is an oversimplification
(fundamental analysis goes beyond just the financial statements) for the purposes
of this tutorial, this simple tenet holds true.

Technical traders, on the other hand, believe there is no reason to analyze a

company's fundamentals because these are all accounted for in the stock's price.
Technicians believe that all the information they need about a stock can be found
in its charts.

Time Horizon
Fundamental analysis takes a relatively long-term approach to analyzing the
market compared to technical analysis. While technical analysis can be used on a
timeframe of weeks, days or even minutes, fundamental analysis often looks at
data over a number of years.

The different timeframes that these two approaches use is a result of the nature of
the investing style to which they each adhere. It can take a long time for a
company's value to be reflected in the market, so when a fundamental analyst
estimates intrinsic value, a gain is not realized until the stock's market price rises
to its "correct" value. This type of investing is called value investing and assumes
that the short-term market is wrong, but that the price of a particular stock will
correct itself over the long run. This "long run" can represent a timeframe of as
long as several years, in some cases. (For more insight, read Warren Buffett: How
He Does It and What Is Warren Buffett's Investing Style?)

Furthermore, the numbers that a fundamentalist analyzes are only released over
long periods of time. Financial statements are filed quarterly and changes in
earnings per share don't emerge on a daily basis like price and volume
information. Also remember that fundamentals are the actual characteristics of a
business. New management can't implement sweeping changes overnight and it
takes time to create new products, marketing campaigns, supply chains, etc. Part
of the reason that fundamental analysts use a long-term timeframe, therefore, is
because the data they use to analyze a stock is generated much more slowly than
the price and volume data used by technical analysts.

Trading Versus Investing

Not only is technical analysis more short term in nature that fundamental analysis,
but the goals of a purchase (or sale) of a stock are usually different for each
approach. In general, technical analysis is used for a trade, whereas fundamental
analysis is used to make an investment. Investors buy assets they believe can
increase in value, while traders buy assets they believe they can sell to somebody
else at a greater price. The line between a trade and an investment can be blurry,
but it does characterize a difference between the two schools.

The Critics
Some critics see technical analysis as a form of black magic. Don't be surprised to
see them question the validity of the discipline to the point where they mock its
supporters. In fact, technical analysis has only recently begun to enjoy some
mainstream credibility. While most analysts on Wall Street focus on the
fundamental side, just about any major brokerage now employs technical analysts
as well.

Much of the criticism of technical analysis has its roots in academic theory -
specifically the efficient market hypothesis (EMH). This theory says that the
market's price is always the correct one - any past trading information is already
reflected in the price of the stock and, therefore, any analysis to find undervalued
securities is useless.

There are three versions of EMH. In the first, called weak form efficiency, all past
price information is already included in the current price. According to weak form
efficiency, technical analysis can't predict future movements because all past
information has already been accounted for and, therefore, analyzing the
stock's past price movements will provide no insight into its future movements. In
the second, semi-strong form efficiency, fundamental analysis is also claimed to
be of little use in finding investment opportunities. The third is strong form
efficiency, which states that all information in the market is accounted for in a
stock's price and neither technical nor fundamental analysis can provide investors
with an edge. The vast majority of academics believe in at least the weak version
of EMH, therefore, from their point of view, if technical analysis works, market
efficiency will be called into question. (For more insight, read What Is Market
Efficiency? and Working Through The Efficient Market Hypothesis.)

There is no right answer as to who is correct. There are arguments to be made on

both sides and, therefore, it's up to you to do the homework and determine your
own philosophy.

Can They Co-Exist?

Although technical analysis and fundamental analysis are seen by many as polar
opposites - the oil and water of investing - many market participants have
experienced great success by combining the two. For example, some fundamental
analysts use technical analysis techniques to figure out the best time to enter into
an undervalued security. Oftentimes, this situation occurs when the security is
severely oversold. By timing entry into a security, the gains on the investment can
be greatly improved.

Alternatively, some technical traders might look at fundamentals to add strength to

a technical signal. For example, if a sell signal is given through technical patterns
and indicators, a technical trader might look to reaffirm his or her decision by
looking at some key fundamental data. Oftentimes, having both the fundamentals
and technicals on your side can provide the best-case scenario for a trade.

While mixing some of the components of technical and fundamental analysis is not
well received by the most devoted groups in each school, there are certainly
benefits to at least understanding both schools of thought.

In the following sections, we'll take a more detailed look at technical analysis.

Technical Analysis: The Use Of Trend

One of the most important concepts in
technical analysis is that of trend. The
meaning in finance isn't all that different from the general definition of the term -
a trend is really nothing more than the general direction in which a security or
market is headed. Take a look at the chart below:
 Figure 1

It isn't hard to see that the trend in Figure 1 is up. However, it's not always this
easy to see a trend:

Figure 2

There are lots of ups and downs in this chart, but there isn't a clear indication of
which direction this security is headed.

A More Formal Definition

Unfortunately, trends are not always easy to see. In other words, defining a
trend goes well beyond the obvious. In any given chart, you will probably notice
that prices do not tend to move in a straight line in any direction, but rather in a
series of highs and lows. In technical analysis, it is the movement of the highs
and lows that constitutes a trend. For example, an uptrend is classified as a
series of higher highs and higher lows, while a downtrend is one of lower lows
and lower highs.

Figure 3

Figure 3 is an example of an uptrend. Point 2 in the chart is the first high, which
is determined after the price falls from this point. Point 3 is the low that is
established as the price falls from the high. For this to remain an uptrend, each
successive low must not fall below the previous lowest point or the trend is
deemed a reversal.

Types of Trend
There are three types of trend:

• Uptrends
• Downtrends
• Sideways/Horizontal Trends

As the names imply, when each successive peak and trough is higher, it's
referred to as an upward trend. If the peaks and troughs are getting lower, it's a
downtrend. When there is little movement up or down in the peaks and troughs,
it's a sideways or horizontal trend. If you want to get really technical, you might
even say that a sideways trend is actually not a trend on its own, but a lack of a
well-defined trend in either direction. In any case, the market can really only
trend in these three ways: up, down or nowhere. (For more insight, see Peak-
And-Trough Analysis.)

Trend Lengths
Along with these three trend directions, there are three trend classifications. A
trend of any direction can be classified as a long-term trend, intermediate trend
or a short-term trend. In terms of the stock market, a major trend is generally
categorized as one lasting longer than a year. An intermediate trend is
considered to last between one and three months and a near-term trend is
anything less than a month. A long-term trend is composed of several
intermediate trends, which often move against the direction of the major trend. If
the major trend is upward and there is a downward correction in price movement
followed by a continuation of the uptrend, the correction is considered to be an
intermediate trend. The short-term trends are components of both major and
intermediate trends. Take a look a Figure 4 to get a sense of how these three
trend lengths might look.

Figure 4

When analyzing trends, it is important that the chart is constructed to best reflect
the type of trend being analyzed. To help identify long-term trends, weekly
charts or daily charts spanning a five-year period are used by chartists to get a
better idea of the long-term trend. Daily data charts are best used when
analyzing both intermediate and short-term trends. It is also important to
remember that the longer the trend, the more important it is; for example, a one-
month trend is not as significant as a five-year trend. (To read more, see Short-,
Intermediate- And Long-Term Trends.)

Trendlines
A trendline is a simple charting technique that adds a line to a chart to represent
the trend in the market or a stock. Drawing a trendline is as simple as drawing a
straight line that follows a general trend. These lines are used to clearly show
the trend and are also used in the identification of trend reversals.

As you can see in Figure 5, an upward trendline is drawn at the lows of an

upward trend. This line represents the support the stock has every time it moves
from a high to a low. Notice how the price is propped up by this support. This
type of trendline helps traders to anticipate the point at which a stock's price will
begin moving upwards again. Similarly, a downward trendline is drawn at the
highs of the downward trend. This line represents the resistance level that a
stock faces every time the price moves from a low to a high. (To read more, see
Support & Resistance Basics and Support And Resistance Zones - Part 1 and
Part 2.)

Figure 5

Channels
A channel, or channel lines, is the addition of two parallel trendlines that act as
strong areas of support and resistance. The upper trendline connects a series of
highs, while the lower trendline connects a series of lows. A channel can slope
upward, downward or sideways but, regardless of the direction, the
interpretation remains the same. Traders will expect a given security to trade
between the two levels of support and resistance until it breaks beyond one of
the levels, in which case traders can expect a sharp move in the direction of the
break. Along with clearly displaying the trend, channels are mainly used to
illustrate important areas of support and resistance.

Figure 6

Figure 6 illustrates a descending channel on a stock chart; the upper trendline

has been placed on the highs and the lower trendline is on the lows. The price
has bounced off of these lines several times, and has remained range-bound for
several months. As long as the price does not fall below the lower line or move
beyond the upper resistance, the range-bound downtrend is expected to
continue.

The Importance of Trend

It is important to be able to understand and identify trends so that you can trade
with rather than against them. Two important sayings in technical analysis are
"the trend is your friend" and "don't buck the trend," illustrating how important
trend analysis is for technical traders.
Technical Analysis: Support And
Resistance
Once you understand the concept of a
trend, the next major concept is that of support and resistance. You'll often hear
technical analysts talk about the ongoing battle between the bulls and the bears,
or the struggle between buyers (demand) and sellers (supply). This is revealed
by the prices a security seldom moves above (resistance) or below (support).

Figure 1

As you can see in Figure 1, support is the price level through which a stock or
market seldom falls (illustrated by the blue arrows). Resistance, on the other
hand, is the price level that a stock or market seldom surpasses (illustrated by
the red arrows).

Why Does it Happen?

These support and resistance levels are seen as important in terms of market
psychology and supply and demand. Support and resistance levels are the
levels at which a lot of traders are willing to buy the stock (in the case of a
support) or sell it (in the case of resistance). When these trendlines are broken,
the supply and demand and the psychology behind the stock's movements is
thought to have shifted, in which case new levels of support and resistance will
likely be established.

Round Numbers and Support and Resistance

One type of universal support and resistance that tends to be seen across a
large number of securities is round numbers. Round numbers like 10, 20, 35,
50, 100 and 1,000 tend be important in support and resistance levels because
they often represent the major psychological turning points at which many
traders will make buy or sell decisions.

Buyers will often purchase large amounts of stock once the price starts to fall
toward a major round number such as $50, which makes it more difficult for
shares to fall below the level. On the other hand, sellers start to sell off a stock
as it moves toward a round number peak, making it difficult to move past this
upper level as well. It is the increased buying and selling pressure at these
levels that makes them important points of support and resistance and, in many
cases, major psychological points as well.

Role Reversal
Once a resistance or support level is broken, its role is reversed. If the price falls
below a support level, that level will become resistance. If the price rises above
a resistance level, it will often become support. As the price moves past a level
of support or resistance, it is thought that supply and demand has shifted,
causing the breached level to reverse its role. For a true reversal to occur,
however, it is important that the price make a strong move through either the
support or resistance. (For further reading, see Retracement Or Reversal: Know
The Difference.)

Figure 2

For example, as you can see in Figure 2, the dotted line is shown as a level of
resistance that has prevented the price from heading higher on two previous
occasions (Points 1 and 2). However, once the resistance is broken, it becomes
a level of support (shown by Points 3 and 4) by propping up the price and
preventing it from heading lower again.
Many traders who begin using technical analysis find this concept hard to
believe and don't realize that this phenomenon occurs rather frequently, even
with some of the most well-known companies. For example, as you can see in
Figure 3, this phenomenon is evident on the Wal-Mart Stores Inc. (WMT) chart
between 2003 and 2006. Notice how the role of the $51 level changes from a
strong level of support to a level of resistance.

Figure 3

In almost every case, a stock will have both a level of support and a level of
resistance and will trade in this range as it bounces between these levels. This
is most often seen when a stock is trading in a generally sideways manner as
the price moves through successive peaks and troughs, testing resistance and
support.

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The Importance of Support and Resistance

Support and resistance analysis is an important part of trends because it can be
used to make trading decisions and identify when a trend is reversing. For
example, if a trader identifies an important level of resistance that has been
tested several times but never broken, he or she may decide to take profits as
the security moves toward this point because it is unlikely that it will move past
this level.

Support and resistance levels both test and confirm trends and need to be
monitored by anyone who uses technical analysis. As long as the price of the
share remains between these levels of support and resistance, the trend is likely
to continue. It is important to note, however, that a break beyond a level of
support or resistance does not always have to be a reversal. For example, if
prices moved above the resistance levels of an upward trending channel, the
trend has accelerated, not reversed. This means that the price appreciation is
expected to be faster than it was in the channel.

Being aware of these important support and resistance points should affect the
way that you trade a stock. Traders should avoid placing orders at these major
points, as the area around them is usually marked by a lot of volatility. If you feel
confident about making a trade near a support or resistance level, it is important
that you follow this simple rule: do not place orders directly at the support or
resistance level. This is because in many cases, the price never actually
reaches the whole number, but flirts with it instead. So if you're bullish on a
stock that is moving toward an important support level, do not place the trade at
the support level. Instead, place it above the support level, but within a few
points. On the other hand, if you are placing stops or short selling, set up your
trade price at or below the level of support.

Technical Analysis: The Importance Of

Volume
To this point, we've only discussed the price of a security. While price is the
primary item of concern in technical analysis, volume is also extremely
important.

What is Volume?
Volume is simply the number of shares or contracts that trade over a given
period of time, usually a day. The higher the volume, the more active the
security. To determine the movement of the volume (up or down), chartists look
at the volume bars that can usually be found at the bottom of any chart. Volume
bars illustrate how many shares have traded per period and show trends in the
same way that prices do. (For further reading, see Price Patterns - Part 3,
Gauging Support And Resistance With Price By Volume.)

Why Volume is Important

Volume is an important aspect of technical analysis because it is used to
confirm trends and chart patterns. Any price movement up or down with
relatively high volume is seen as a stronger, more relevant move than a similar
move with weak volume. Therefore, if you are looking at a large price
movement, you should also examine the
volume to see whether it tells the same
story.

Say, for example, that a stock jumps 5% in one trading day after being in a long
downtrend. Is this a sign of a trend reversal? This is where volume helps
traders. If volume is high during the day relative to the average daily volume, it is
a sign that the reversal is probably for real. On the other hand, if the volume
is below average, there may not be enough conviction to support a true trend
reversal. (To read more, check out Trading Volume - Crowd Psychology.)

Volume should move with the trend. If prices are moving in an upward trend,
volume should increase (and vice versa). If the previous relationship between
volume and price movements starts to deteriorate, it is usually a sign of
weakness in the trend. For example, if the stock is in an uptrend but the up
trading days are marked with lower volume, it is a sign that the trend is starting
to lose its legs and may soon end.
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When volume tells a different story, it is a case of divergence, which refers to a

contradiction between two different indicators. The simplest example of
divergence is a clear upward trend on declining volume. (For additional insight,
read Divergences, Momentum And Rate Of Change.)

Volume and Chart Patterns

The other use of volume is to confirm chart patterns. Patterns such as head and
shoulders, triangles, flags and other price patterns can be confirmed with
volume, a process which we'll describe in more detail later in this tutorial. In
most chart patterns, there are several pivotal points that are vital to what the
chart is able to convey to chartists. Basically, if the volume is not there to
confirm the pivotal moments of a chart pattern, the quality of the signal formed
by the pattern is weakened.

Volume Precedes Price

Another important idea in technical analysis is that price is preceded by volume.
Volume is closely monitored by technicians and chartists to form ideas on
upcoming trend reversals. If volume is starting to decrease in an uptrend, it is
usually a sign that the upward run is about to end.

Now that we have a better understanding of some of the important factors of

technical analysis, we can move on to charts, which help to identify trading
opportunities in prices movements.

Technical Analysis: What Is A Chart?

In technical analysis, charts are similar to the charts that you see in any business
setting. A chart is simply a graphical representation of a series of prices over a set
time frame. For example, a chart may show a stock's price movement over a one-
year period, where each point on the graph represents the closing price for each
day the stock is traded:
 Figure 1

Figure 1 provides an example of a basic chart. It is a representation of the price

movements of a stock over a 1.5 year period. The bottom of the graph, running
horizontally (x-axis), is the date or time scale. On the right hand side, running
vertically (y-axis), the price of the security is shown. By looking at the graph we
see that in October 2004 (Point 1), the price of this stock was around $245,
whereas in June 2005 (Point 2), the stock's price is around $265. This tells us that
the stock has risen between October 2004 and June 2005.

Chart Properties
There are several things that you should be aware of when looking at a chart, as
these factors can affect the information that is provided. They include the time
scale, the price scale and the price point properties used.

The Time Scale

The time scale refers to the range of dates at the bottom of the chart, which can
vary from decades to seconds. The most frequently used time scales are intraday,
daily, weekly, monthly, quarterly and annually. The shorter the time frame, the
more detailed the chart. Each data point can represent the closing price of the
period or show the open, the high, the low and the close depending on the chart
used.

Intraday charts plot price movement within the period of one day. This means that
the time scale could be as short as five minutes or could cover the whole trading
day from the opening bell to the closing bell.

Daily charts are comprised of a series of price movements in which each price
point on the chart is a full day’s trading condensed into one point. Again, each
point on the graph can be simply the closing price or can entail the open, high, low
and close for the stock over the day. These data points are spread out over
weekly, monthly and even yearly time scales to monitor both short-term and
intermediate trends in price movement.

Weekly, monthly, quarterly and yearly charts are used to analyze longer term
trends in the movement of a stock's price. Each data point in these graphs will be a
condensed version of what happened over the specified period. So for a weekly
chart, each data point will be a representation of the price movement of the week.
For example, if you are looking at a chart of weekly data spread over a five-year
period and each data point is the closing price for the week, the price that is
plotted will be the closing price on the last trading day of the week, which is usually
a Friday.

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The Price Scale and Price Point Properties

The price scale is on the right-hand side of the chart. It shows a stock's current
price and compares it to past data points. This may seem like a simple concept in
that the price scale goes from lower prices to higher prices as you move along the
scale from the bottom to the top. The problem, however, is in the structure of the
scale itself. A scale can either be constructed in a linear (arithmetic) or logarithmic
way, and both of these options are available on most charting services.

If a price scale is constructed using a linear scale, the space between each price
point (10, 20, 30, 40) is separated by an equal amount. A price move from 10 to 20
on a linear scale is the same distance on the chart as a move from 40 to 50. In
other words, the price scale measures moves in absolute terms and does not
show the effects of percent change.
Figure 2

If a price scale is in logarithmic terms, then the distance between points will be equal
in terms of percent change. A price change from 10 to 20 is a 100% increase in the
price while a move from 40 to 50 is only a 25% change, even though they are
represented by the same distance on a linear scale. On a logarithmic scale, the
distance of the 100% price change from 10 to 20 will not be the same as the 25%
change from 40 to 50. In this case, the move from 10 to 20 is represented by a
larger space one the chart, while the move from 40 to 50, is represented by a
smaller space because, percentage-wise, it indicates a smaller move. In Figure 2,
the logarithmic price scale on the right leaves the same amount of space between
10 and 20 as it does between 20 and 40 because these both represent 100%
increases.

Technical Analysis: Chart Types

There are four main types of charts that are used by investors and traders
depending on the information that they are seeking and their individual skill levels.
The chart types are: the line chart, the bar chart, the candlestick chart and the
point and figure chart. In the following sections, we will focus on the S&P 500
Index during the period of January 2006 through May 2006. Notice how the data
used to create the charts is the same, but the way the data is plotted and shown in
the charts is different.

Line Chart
The most basic of the four charts is the line chart because it represents only the
closing prices over a set period of time. The line is formed by connecting the
closing prices over the time frame. Line charts do not provide visual information of
the trading range for the individual points such as the high, low and opening
prices. However, the closing price is often considered to be the most important
price in stock data compared to the high and low for the day and this is why it is
the only value used in line charts.

Figure 1: A line chart

Bar Charts
The bar chart expands on the line chart by adding several more key pieces of
information to each data point. The chart is made up of a series of vertical lines
that represent each data point. This vertical line represents the high and low for
the trading period, along with the closing price. The close and open are
represented on the vertical line by a horizontal dash. The opening price on a bar
chart is illustrated by the dash that is located on the left side of the vertical bar.
Conversely, the close is represented by the dash on the right. Generally, if the left
dash (open) is lower than the right dash (close) then the bar will be shaded black,
representing an up period for the stock, which means it has gained value. A bar
that is colored red signals that the stock has gone down in value over that period.
When this is the case, the dash on the right (close) is lower than the dash on the
left (open).
 Figure 2: A bar chart

Candlestick Charts
The candlestick chart is similar to a bar chart, but it differs in the way that it is
visually constructed. Similar to the bar chart, the candlestick also has a thin vertical
line showing the period's trading range. The difference comes in the formation of a
wide bar on the vertical line, which illustrates the difference between the open and
close. And, like bar charts, candlesticks also rely heavily on the use of colors to
explain what has happened during the trading period. A major problem with the
candlestick color configuration, however, is that different sites use different
standards; therefore, it is important to understand the candlestick configuration
used at the chart site you are working with. There are two color constructs for days
up and one for days that the price falls. When the price of the stock is up and
closes above the opening trade, the candlestick will usually be white or clear. If the
stock has traded down for the period, then the candlestick will usually be red or
black, depending on the site. If the stock's price has closed above the previous
day’s close but below the day's open, the candlestick will be black or filled with the
color that is used to indicate an up day. (To read more, see The Art Of Candlestick
Charting - Part 1, Part 2, Part 3 and Part 4.)
 Figure 3: A candlestick chart

Point and Figure Charts

The point and figure chart is not well known or used by the average investor but it
has had a long history of use dating back to the first technical traders. This type of
chart reflects price movements and is not as concerned about time and volume in
the formulation of the points. The point and figure chart removes the noise, or
insignificant price movements, in the stock, which can distort traders' views of the
price trends. These types of charts also try to neutralize the skewing effect that
time has on chart analysis. (For further reading, see Point And Figure Charting.)

Figure 4: A point and figure chart

When first looking at a point and figure chart, you will notice a series of Xs and Os.
 The Xs represent upward price trends and the Os represent downward price
trends. There are also numbers and letters in the chart; these represent months,
and give investors an idea of the date. Each box on the chart represents the price
scale, which adjusts depending on the price of the stock: the higher the stock's
price the more each box represents. On most charts where the price is between
$20 and $100, a box represents $1, or 1 point for the stock. The other critical point
of a point and figure chart is the reversal criteria. This is usually set at three but it
can also be set according to the chartist's discretion. The reversal criteria set how
much the price has to move away from the high or low in the price trend to create a
new trend or, in other words, how much the price has to move in order for a
column of Xs to become a column of Os, or vice versa. When the price trend has
moved from one trend to another, it shifts to the right, signaling a trend change.

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Conclusion
Charts are one of the most fundamental aspects of technical analysis. It is important
that you clearly understand what is being shown on a chart and the information that
it provides. Now that we have an idea of how charts are constructed, we can move
on to the different types of chart patterns.

Technical Analysis: Chart Patterns

A chart pattern is a distinct formation on a stock chart that creates a trading signal,
or a sign of future price movements. Chartists use these patterns to identify current
trends and trend reversals and to trigger buy and sell signals.

In the first section of this tutorial, we talked

about the three assumptions of technical
analysis, the third of which was that in
technical analysis, history repeats itself.
The theory behind chart patters is based
on this assumption. The idea is that certain patterns are seen many times, and that
these patterns signal a certain high probability move in a stock. Based on the
historic trend of a chart pattern setting up a certain price movement, chartists look
for these patterns to identify trading opportunities.

While there are general ideas and components to every chart pattern, there is no
chart pattern that will tell you with 100% certainty where a security is headed. This
creates some leeway and debate as to what a good pattern looks like, and is a
major reason why charting is often seen as more of an art than a science. (For
more insight, see Is finance an art or a science?)

There are two types of patterns within this area of technical analysis, reversal and
continuation. A reversal pattern signals that a prior trend will reverse upon
completion of the pattern. A continuation pattern, on the other hand, signals that a
trend will continue once the pattern is complete. These patterns can be found over
charts of any timeframe. In this section, we will review some of the more popular
chart patterns. (To learn more, check out Continuation Patterns - Part 1, Part 2,
Part 3 and Part 4.)

Head and Shoulders

This is one of the most popular and reliable chart patterns in technical analysis.
Head and shoulders is a reversal chart pattern that when formed, signals that the
security is likely to move against the previous trend. As you can see in Figure 1,
there are two versions of the head and shoulders chart pattern. Head and
shoulders top (shown on the left) is a chart pattern that is formed at the high of an
upward movement and signals that the upward trend is about to end. Head and
shoulders bottom, also known as inverse head and shoulders (shown on the right)
is the lesser known of the two, but is used to signal a reversal in a downtrend.
Figure 1: Head and shoulders top is shown on the left. Head and shoulders bottom, or inverse head and shoulders, is
on the right.

Both of these head and shoulders patterns are similar in that there are four main
parts: two shoulders, a head and a neckline. Also, each individual head and
shoulder is comprised of a high and a low. For example, in the head and shoulders
top image shown on the left side in Figure 1, the left shoulder is made up of a high
followed by a low. In this pattern, the neckline is a level of support or resistance.
Remember that an upward trend is a period of successive rising highs and rising
lows. The head and shoulders chart pattern, therefore, illustrates a weakening in a
trend by showing the deterioration in the successive movements of the highs and
lows. (To learn more, see Price Patterns - Part 2.)

Cup and Handle

A cup and handle chart is a bullish continuation pattern in which the upward trend
has paused but will continue in an upward direction once the pattern is confirmed.

Figure 2

As you can see in Figure 2, this price pattern forms what looks like a cup, which is
preceded by an upward trend. The handle follows the cup formation and is formed
by a generally downward/sideways movement in the security's price. Once the
price movement pushes above the resistance lines formed in the handle, the
upward trend can continue. There is a wide ranging time frame for this type of
pattern, with the span ranging from several months to more than a year.

Double Tops and Bottoms

This chart pattern is another well-known pattern that signals a trend reversal - it is
 considered to be one of the most reliable and is commonly used. These patterns
are formed after a sustained trend and signal to chartists that the trend is about to
reverse. The pattern is created when a price movement tests support or resistance
levels twice and is unable to break through. This pattern is often used to signal
intermediate and long-term trend reversals.

Figure 3: A double top pattern is shown on the left, while a double bottom pattern is shown on the
right.

In the case of the double top pattern in Figure 3, the price movement has twice
tried to move above a certain price level. After two unsuccessful attempts at
pushing the price higher, the trend reverses and the price heads lower. In the case
of a double bottom (shown on the right), the price movement has tried to go lower
twice, but has found support each time. After the second bounce off of the support,
the security enters a new trend and heads upward. (For more in-depth reading,
see The Memory Of Price and Price Patterns - Part 4.)

Triangles
Triangles are some of the most well-known chart patterns used in technical
analysis. The three types of triangles, which vary in construct and implication, are
the symmetrical triangle, ascending and descending triangle. These chart patterns
are considered to last anywhere from a couple of weeks to several months.
Figure 4

The symmetrical triangle in Figure 4 is a pattern in which two trendlines converge

toward each other. This pattern is neutral in that a breakout to the upside or
downside is a confirmation of a trend in that direction. In an ascending triangle, the
upper trendline is flat, while the bottom trendline is upward sloping. This is
generally thought of as a bullish pattern in which chartists look for an upside
breakout. In a descending triangle, the lower trendline is flat and the upper
trendline is descending. This is generally seen as a bearish pattern where chartists
look for a downside breakout.

Flag and Pennant

These two short-term chart patterns are continuation patterns that are formed
when there is a sharp price movement followed by a generally sideways price
movement. This pattern is then completed upon another sharp price movement in
the same direction as the move that started the trend. The patterns are generally
thought to last from one to three weeks.
Figure 5

As you can see in Figure 5, there is little difference between a pennant and a flag.
The main difference between these price movements can be seen in the middle
section of the chart pattern. In a pennant, the middle section is characterized by
converging trendlines, much like what is seen in a symmetrical triangle. The
middle section on the flag pattern, on the other hand, shows a channel pattern,
with no convergence between the trendlines. In both cases, the trend is expected
to continue when the price moves above the upper trendline.

Wedge
The wedge chart pattern can be either a continuation or reversal pattern. It is
similar to a symmetrical triangle except that the wedge pattern slants in an upward
or downward direction, while the symmetrical triangle generally shows a sideways
movement. The other difference is that wedges tend to form over longer periods,
usually between three and six months.

Figure 6

The fact that wedges are classified as both continuation and reversal patterns can
make reading signals confusing. However, at the most basic level, a falling wedge
is bullish and a rising wedge is bearish. In Figure 6, we have a falling wedge in
which two trendlines are converging in a downward direction. If the price was to
rise above the upper trendline, it would form a continuation pattern, while a move
below the lower trendline would signal a reversal pattern.

Gaps
A gap in a chart is an empty space between a trading period and the following
trading period. This occurs when there is a large difference in prices between two
sequential trading periods. For example, if the trading range in one period is
between $25 and $30 and the next trading period opens at $40, there will be a
large gap on the chart between these two periods. Gap price movements can be
found on bar charts and candlestick charts but will not be found on point and figure
or basic line charts. Gaps generally show that something of significance has
happened in the security, such as a better-than-expected earnings announcement.

There are three main types of gaps, breakaway, runaway (measuring) and
exhaustion. A breakaway gap forms at the start of a trend, a runaway gap forms
during the middle of a trend and an exhaustion gap forms near the end of a trend.
(For more insight, read Playing The Gap.)

Triple Tops and Bottoms

Triple tops and triple bottoms are another type of reversal chart pattern in chart
analysis. These are not as prevalent in charts as head and shoulders and double
tops and bottoms, but they act in a similar fashion. These two chart patterns are
formed when the price movement tests a level of support or resistance three times
and is unable to break through; this signals a reversal of the prior trend.
 Figure 7

Confusion can form with triple tops and bottoms during the formation of the pattern
because they can look similar to other chart patterns. After the first two
support/resistance tests are formed in the price movement, the pattern will look like
a double top or bottom, which could lead a chartist to enter a reversal position too
soon.

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Rounding Bottom
A rounding bottom, also referred to as a saucer bottom, is a long-term reversal
pattern that signals a shift from a downward trend to an upward trend. This pattern
is traditionally thought to last anywhere from several months to several years.
 Figure 8

A rounding bottom chart pattern looks similar to a cup and handle pattern but
without the handle. The long-term nature of this pattern and the lack of a
confirmation trigger, such as the handle in the cup and handle, makes it a difficult
pattern to trade.

We have finished our look at some of the more popular chart patterns. You should
now be able to recognize each chart pattern as well the signal it can form for
chartists. We will now move on to other technical techniques and examine how they
are used by technical traders to gauge price movements.

Technical Analysis: Moving Averages

Most chart patterns show a lot of variation in price movement. This can make it
difficult for traders to get an idea of a security's overall trend. One simple method
traders use to combat this is to apply moving averages. A moving average is the
average price of a security over a set amount of time. By plotting a
security's average price, the price movement is smoothed out. Once the day-to-
day fluctuations are removed, traders are better able to identify the true trend and
increase the probability that it will work in their favor. (To learn more, read the
Moving Averages tutorial.)

Types of Moving Averages

There are a number of different types of
moving averages that vary in the way they
are calculated, but how each average is
interpreted remains the same. The
calculations only differ in regards to the weighting that they place on the price data,
shifting from equal weighting of each price point to more weight being placed on
recent data. The three most common types of moving averages are simple, linear
and exponential.

Simple Moving Average (SMA)

This is the most common method used to calculate the moving average of prices.
It simply takes the sum of all of the past closing prices over the time period and
divides the result by the number of prices used in the calculation. For example, in
a 10-day moving average, the last 10 closing prices are added together and then
divided by 10. As you can see in Figure 1, a trader is able to make the average
less responsive to changing prices by increasing the number of periods used in the
calculation. Increasing the number of time periods in the calculation is one of the
best ways to gauge the strength of the long-term trend and the likelihood that it will
reverse.

Figure 1

Many individuals argue that the usefulness of this type of average is limited
because each point in the data series has the same impact on the result
regardless of where it occurs in the sequence. The critics argue that the most
recent data is more important and, therefore, it should also have a higher
weighting. This type of criticism has been one of the main factors leading to the
invention of other forms of moving averages.

Linear Weighted Average

This moving average indicator is the least common out of the three and is used to
address the problem of the equal weighting. The linear weighted moving average
is calculated by taking the sum of all the closing prices over a certain time period
and multiplying them by the position of the data point and then dividing by the sum
of the number of periods. For example, in a five-day linear weighted average,
today's closing price is multiplied by five, yesterday's by four and so on until the
first day in the period range is reached. These numbers are then added together
and divided by the sum of the multipliers.

Exponential Moving Average (EMA)

This moving average calculation uses a smoothing factor to place a higher weight
on recent data points and is regarded as much more efficient than the linear
weighted average. Having an understanding of the calculation is not generally
required for most traders because most charting packages do the calculation for
you. The most important thing to remember about the exponential moving average
is that it is more responsive to new information relative to the simple moving
average. This responsiveness is one of the key factors of why this is the moving
average of choice among many technical traders. As you can see in Figure 2, a
15-period EMA rises and falls faster than a 15-period SMA. This slight difference
doesn’t seem like much, but it is an important factor to be aware of since it can
affect returns.

Figure 2

Major Uses of Moving Averages

Moving averages are used to identify current trends and trend reversals as well as
to set up support and resistance levels.

Moving averages can be used to quickly identify whether a security is moving in an

uptrend or a downtrend depending on the direction of the moving average. As you
can see in Figure 3, when a moving average is heading upward and the price is
above it, the security is in an uptrend. Conversely, a downward sloping moving
average with the price below can be used to signal a downtrend.
 Figure 3

Another method of determining momentum is to look at the order of a pair of

moving averages. When a short-term average is above a longer-term average, the
trend is up. On the other hand, a long-term average above a shorter-term average
signals a downward movement in the trend.

Moving average trend reversals are formed in two main ways: when the price
moves through a moving average and when it moves through moving average
crossovers. The first common signal is when the price moves through an important
moving average. For example, when the price of a security that was in an uptrend
falls below a 50-period moving average, like in Figure 4, it is a sign that the
uptrend may be reversing.

Figure 4

The other signal of a trend reversal is when one moving average crosses through
another. For example, as you can see in Figure 5, if the 15-day moving average
crosses above the 50-day moving average, it is a positive sign that the price will
start to increase.

Figure 5

If the periods used in the calculation are relatively short, for example 15 and 35,
this could signal a short-term trend reversal. On the other hand, when two
averages with relatively long time frames cross over (50 and 200, for example),
this is used to suggest a long-term shift in trend.

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Another major way moving averages are used is to identify support and resistance
levels. It is not uncommon to see a stock that has been falling stop its decline and
reverse direction once it hits the support of a major moving average. A move
through a major moving average is often used as a signal by technical traders that
the trend is reversing. For example, if the price breaks through the 200-day moving
average in a downward direction, it is a signal that the uptrend is reversing.
 Figure 6

Moving averages are a powerful tool for analyzing the trend in a security. They
provide useful support and resistance points and are very easy to use. The most
common time frames that are used when creating moving averages are the 200-
day, 100-day, 50-day, 20-day and 10-day. The 200-day average is thought to be a
good measure of a trading year, a 100-day average of a half a year, a 50-day
average of a quarter of a year, a 20-day average of a month and 10-day average of
two weeks.

Moving averages help technical traders smooth out some of the noise that is found
in day-to-day price movements, giving traders a clearer view of the price trend. So
far we have been focused on price movement, through charts and averages. In the
next section, we'll look at some other techniques used to confirm price movement
and patterns.

Technical Analysis: Indicators And

Oscillators
Indicators are calculations based on the price and the volume of a security that
measure such things as money flow, trends, volatility and momentum. Indicators
are used as a secondary measure to the actual price movements and add
additional information to the analysis of securities. Indicators are used in two main
ways: to confirm price movement and the quality of chart patterns, and to form buy
and sell signals.
There are two main types of indicators: leading and lagging. A leading indicator
precedes price movements, giving them a predictive quality, while a lagging
indicator is a confirmation tool because it follows price movement. A leading
indicator is thought to be the strongest during periods of sideways or non-trending
trading ranges, while the lagging indicators are still useful during trending periods.

There are also two types of indicator constructions: those that fall in a bounded
range and those that do not. The ones that are bound within a range are called
oscillators - these are the most common type of indicators. Oscillator indicators
have a range, for example between zero and 100, and signal periods where the
security is overbought (near 100) or oversold (near zero). Non-bounded indicators
still form buy and sell signals along with displaying strength or weakness, but they
vary in the way they do this.

The two main ways that indicators are used to form buy and sell signals in
technical analysis is through crossovers and divergence. Crossovers are the most
popular and are reflected when either the
price moves through the moving average,
or when two different moving averages
cross over each other.The second way
indicators are used is through divergence,
which happens when the direction of the price trend and the direction of the
indicator trend are moving in the opposite direction. This signals to indicator users
that the direction of the price trend is weakening.

Indicators that are used in technical analysis provide an extremely useful source of
additional information. These indicators help identify momentum, trends, volatility
and various other aspects in a security to aid in the technical analysis of trends. It
is important to note that while some traders use a single indicator solely for buy
and sell signals, they are best used in conjunction with price movement, chart
patterns and other indicators.

Accumulation/Distribution Line
The accumulation/distribution line is one of the more popular volume indicators
that measures money flows in a security. This indicator attempts to measure the
ratio of buying to selling by comparing the price movement of a period to the
volume of that period.

Calculated:

Acc/Dist = ((Close - Low) - (High - Close)) /

 (High - Low) * Period's Volume

This is a non-bounded indicator that simply keeps a running sum over the period of
the security. Traders look for trends in this indicator to gain insight on the amount
of purchasing compared to selling of a security. If a security has an
accumulation/distribution line that is trending upward, it is a sign that there is more
buying than selling.

Average Directional Index

The average directional index (ADX) is a trend indicator that is used to measure
the strength of a current trend. The indicator is seldom used to identify the
direction of the current trend, but can identify the momentum behind trends.

The ADX is a combination of two price movement measures: the positive

directional indicator (+DI) and the negative directional indicator (-DI). The ADX
measures the strength of a trend but not the direction. The +DI measures the
strength of the upward trend while the -DI measures the strength of the downward
trend. These two measures are also plotted along with the ADX line. Measured on
a scale between zero and 100, readings below 20 signal a weak trend while
readings above 40 signal a strong trend.

Aroon
The Aroon indicator is a relatively new technical indicator that was created in 1995.
The Aroon is a trending indicator used to measure whether a security is in an
uptrend or downtrend and the magnitude of that trend. The indicator is also used
to predict when a new trend is beginning.

The indicator is comprised of two lines, an "Aroon up" line (blue line) and an
"Aroon down" line (red dotted line). The Aroon up line measures the amount of
time it has been since the highest price during the time period. The Aroon down
line, on the other hand, measures the amount of time since the lowest price during
the time period. The number of periods that are used in the calculation is
dependent on the time frame that the user wants to analyze.
 Figure 1
Aroon Oscillator
An expansion of the Aroon is the Aroon oscillator, which simply plots the difference
between the Aroon up and down lines by subtracting the two lines. This line is then
plotted between a range of -100 and 100. The centerline at zero in the oscillator is
considered to be a major signal line determining the trend. The higher the value of
the oscillator from the centerline point, the more upward strength there is in the
security; the lower the oscillator's value is from the centerline, the more downward
pressure. A trend reversal is signaled when the oscillator crosses through the
centerline. For example, when the oscillator goes from positive to negative, a
downward trend is confirmed. Divergence is also used in the oscillator to predict
trend reversals. A reversal warning is formed when the oscillator and the price
trend are moving in an opposite direction.

The Aroon lines and Aroon oscillators are fairly simple concepts to understand but
yield powerful information about trends. This is another great indicator to add to
any technical trader's arsenal.

Moving Average Convergence

The moving average convergence divergence (MACD) is one of the most well
known and used indicators in technical analysis. This indicator is comprised of two
exponential moving averages, which help to measure momentum in the security.
The MACD is simply the difference between these two moving averages plotted
against a centerline. The centerline is the point at which the two moving averages
are equal. Along with the MACD and the centerline, an exponential moving
average of the MACD itself is plotted on the chart. The idea behind this momentum
indicator is to measure short-term momentum compared to longer term momentum
to help signal the current direction of momentum.
 MACD= shorter term moving average -
longer term moving average

When the MACD is positive, it signals that the shorter term moving average is
above the longer term moving average and suggests upward momentum. The
opposite holds true when the MACD is negative - this signals that the shorter term
is below the longer and suggest downward momentum. When the MACD line
crosses over the centerline, it signals a crossing in the moving averages. The most
common moving average values used in the calculation are the 26-day and 12-day
exponential moving averages. The signal line is commonly created by using a
nine-day exponential moving average of the MACD values. These values can be
adjusted to meet the needs of the technician and the security. For more volatile
securities, shorter term averages are used while less volatile securities should
have longer averages.

Another aspect to the MACD indicator that is often found on charts is the MACD
histogram. The histogram is plotted on the centerline and represented by bars.
Each bar is the difference between the MACD and the signal line or, in most
cases, the nine-day exponential moving average. The higher the bars are in either
direction, the more momentum behind the direction in which the bars point. (For
more on this, see Moving Average Convergence Divergence - Part 1 and Part 2,
and Trading The MACD Divergence.)

As you can see in Figure 2, one of the most common buy signals is generated
when the MACD crosses above the signal line (blue dotted line), while sell signals
often occur when the MACD crosses below the signal.
 Figure 2

Relative Strength Index

The relative strength index (RSI) is another one of the most used and well-known
momentum indicators in technical analysis. RSI helps to signal overbought and
oversold conditions in a security. The indicator is plotted in a range between zero
and 100. A reading above 70 is used to suggest that a security is overbought,
while a reading below 30 is used to suggest that it is oversold. This indicator helps
traders to identify whether a security’s price has been unreasonably pushed to
current levels and whether a reversal may be on the way.

Figure 3

The standard calculation for RSI uses 14 trading days as the basis, which can be
adjusted to meet the needs of the user. If the trading period is adjusted to use
fewer days, the RSI will be more volatile and will be used for shorter term trades.
(To read more, see Momentum And The Relative Strength Index, Relative
Strength Index And Its Failure-Swing Points and Getting To Know Oscillators -
Part 1 and Part 2.)

On-Balance Volume
The on-balance volume (OBV) indicator is a well-known technical indicator that
reflect movements in volume. It is also one of the simplest volume indicators to
compute and understand.

The OBV is calculated by taking the total volume for the trading period and
assigning it a positive or negative value depending on whether the price is up or
down during the trading period. When price is up during the trading period, the
volume is assigned a positive value, while a negative value is assigned when the
price is down for the period. The positive or negative volume total for the period is
then added to a total that is accumulated from the start of the measure.

It is important to focus on the trend in the OBV - this is more important than the
actual value of the OBV measure. This measure expands on the basic volume
measure by combining volume and price movement. (For more insight, see
Introduction To On-Balance Volume.)

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Stochastic Oscillator
The stochastic oscillator is one of the most recognized momentum indicators used
in technical analysis. The idea behind this indicator is that in an uptrend, the price
should be closing near the highs of the trading range, signaling upward momentum
in the security. In downtrends, the price should be closing near the lows of the
trading range, signaling downward momentum.

The stochastic oscillator is plotted within a range of zero and 100 and signals
overbought conditions above 80 and oversold conditions below 20. The stochastic
oscillator contains two lines. The first line is the %K, which is essentially the raw
measure used to formulate the idea of momentum behind the oscillator. The
second line is the %D, which is simply a moving average of the %K. The %D line is
considered to be the more important of the two lines as it is seen to produce better
signals. The stochastic oscillator generally uses the past 14 trading periods in its
calculation but can be adjusted to meet the needs of the user. (To read more,
check out Getting To Know Oscillators - Part 3.)
 Figure 4

Technical Analysis:
Conclusion
This introductory section of the technical
analysis tutorial has provided a broad
overview of technical analysis.

Here's a brief summary of what we've

covered:

• Technical analysis is a method of

evaluating securities by analyzing the
statistics generated by market activity. It is based on three assumptions: 1) the
market discounts everything, 2) price moves in trends and 3) history tends to
repeat itself.
• Technicians believe that all the information they need about a stock can be found
in its charts.
• Technical traders take a short-term approach to analyzing the market.
• Criticism of technical analysis stems from the efficient market hypothesis, which
states that the market price is always the correct one, making any historical
analysis useless.
• One of the most important concepts in technical analysis is that of a trend, which is
the general direction that a security is headed. There are three types of trends:
uptrends, downtrends and sideways/horizontal trends.
• A trendline is a simple charting technique that adds a line to a chart to represent
the trend in the market or a stock.
• A channel, or channel lines, is the addition of two parallel trendlines that act as
strong areas of support and resistance.
• Support is the price level through which a stock or market seldom falls. Resistance
is the price level that a stock or market seldom surpasses.
• Volume is the number of shares or contracts that trade over a given period of time,
usually a day. The higher the volume, the more active the security.
• A chart is a graphical representation of a series of prices over a set time frame.
• The time scale refers to the range of dates at the bottom of the chart, which can
vary from decades to seconds. The most frequently used time scales are intraday,
daily, weekly, monthly, quarterly and annually.
• The price scale is on the right-hand side of the chart. It shows a stock's current
price and compares it to past data points. It can be either linear or logarithmic.
• There are four main types of charts used by investors and traders: line charts, bar
charts, candlestick charts and point and figure charts.
• A chart pattern is a distinct formation on a stock chart that creates a trading signal,
or a sign of future price movements. There are two types: reversal and
continuation.
• A head and shoulders pattern is reversal pattern that signals a security is likely to
move against its previous trend.
• A cup and handle pattern is a bullish continuation pattern in which the upward
trend has paused but will continue in an upward direction once the pattern is
confirmed.
• Double tops and double bottoms are formed after a sustained trend and signal to
chartists that the trend is about to reverse. The pattern is created when a price
movement tests support or resistance levels twice and is unable to break through.
• A triangle is a technical analysis pattern created by drawing trendlines along a
price range that gets narrower over time because of lower tops and higher
bottoms. Variations of a triangle include ascending and descending triangles.
• Flags and pennants are short-term continuation patterns that are formed when
there is a sharp price movement followed by a sideways price movement.
• The wedge chart pattern can be either a continuation or reversal pattern. It is
similar to a symmetrical triangle except that the wedge pattern slants in an upward
or downward direction.
• A gap in a chart is an empty space between a trading period and the following
trading period. This occurs when there is a large difference in prices between two
sequential trading periods.
• Triple tops and triple bottoms are reversal patterns that are formed when the price
movement tests a level of support or resistance three times and is unable to break
through, signaling a trend reversal.

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• A rounding bottom (or saucer bottom) is a long-term reversal pattern that signals a
shift from a downward trend to an upward trend.
• A moving average is the average price of a security over a set amount of time.
There are three types: simple, linear and exponential.
• Moving averages help technical traders smooth out some of the noise that is found
in day-to-day price movements, giving traders a clearer view of the price trend.
• Indicators are calculations based on the price and the volume of a security that
measure such things as money flow, trends, volatility and momentum. There are
two types: leading and lagging.
• The accumulation/distribution line is a volume indicator that attempts to measure
the ratio of buying to selling of a security.
• The average directional index (ADX) is a trend indicator that is used to measure
the strength of a current trend.
• The Aroon indicator is a trending indicator used to measure whether a security is in
an uptrend or downtrend and the magnitude of that trend.
• The Aroon oscillator plots the difference between the Aroon up and down lines by
subtracting the two lines.
• The moving average convergence divergence (MACD) is comprised of two
exponential moving averages, which help to measure a security's momentum.
• The relative strength index (RSI) helps to signal overbought and oversold
conditions in a security.
• The on-balance volume (OBV) indicator is one of the most well-known technical
indicators that reflects movements in volume.
• The stochastic oscillator compares a security's closing price to its price range over
a given time period.