Technical Analysis Cheatsheet: Twelve Popular Technical Analysis Tools And What They Mean For Your Trading

Technical Analysis is the act of using a share price and volume to determine places to buy and sell.  While it used to be a relatively simple style of analysis, with the invention of computers its use has increased and has become both more simple and more complex.  Simple in that we can now with some programs scan entire markets for a technical signal in under 5 minutes.  Complex, in that technical analysts have invented more complex ways to combine price and volume in order to get what they believe might be a superior result.  Most technical analysis is still, at its core, made up of price and volume.

Below we will look at  ten popular technical anlalysis tools, ranging from simple tools anyone can draw on a chart through to the more complex computerised ones.  Enjoy!

1: Trend Lines

Trend lines are very simply, a line on a chart.  On a simple bar chart a down trend line is drawn over two or more peaks.  An up trend line is drawn over 2 or more troughs.  Traders and investors will often take price crossing above a trend line as a signal to buy, or price crossing below an up trend line as a signal to sell.

The benefits of trend lines are they are very easy to draw, use and learn, and can get you into and out of trades before other methods. 

2: Moving Averages

A moving average is a plot on a bar chart that shows you the average of the last “x” amount of days, weeks, months or years.  To give you an example, a 50 day moving average would be a line on your bar chart that shows the average of the last 50 days in price.  As the price moves and changes, so does the moving average.

Many traders and investors use moving averages as buy and sell signals, as support and resistance or with another moving average or combination where one crossing above another is a buy or sell signal.  Moving averages have been used as part of many automatic trading systems over the years, and can also be separated into Exponential Moving Averages (EMA) where more weight is given to the more recent data, and Simple Moving Averages (MA).

3: Support And Resistance

Price support and resistance is often used by technical analysts for good reason.  Places where large buyers buy and sell become points of support and resistance in the market due to simple laws of supply and demand (i.e. if there are large sellers at a particular price point, it will be hard for the price to rise above this point).

4: Dow’s Theory

Charles Dow’s theory from the late 1800s was three parts: First that the market moves up and down in three phases, from hope, earnings, to euphoria, then from abandonment of hope, lack of earnings, to despair.  Second is his “higher peaks and higher troughs” theory, which according to Dow constitutes a bull market.  Conversely, lower peaks and lower troughs in price would constitute a bear market.  And lastly, the Dow Industrials average and the Dow Transports average ideally make new highs at similar times.  If the Industrials average makes a new high but the Transports does not, it indicates to Dow that there is not as much demand for the goods being manufactured.

5: Fibonnacci Numbers

Leonardo Fibonacci, the Italian economist who introduced the decimal number system to Europe in the 1200s, also invented a number series that was found all throughout the universe: in nature, cells, economics, and life.  The numbers are found by adding the last two numbers in the sequence together, for example: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, and so on.  Dividing a number by its predecessor (i.e. 89 / 55) gives us the “golden mean”, or 1.618.  Now (starting from 0.236 or 23.6%) multiplying onward by 1.618 this gives you a series of percentages, and Technical Analysts around the world have found that the market tends to find support and resistance in the future at and around these percentages!

6: Elliott Wave Theory

Taking Fibonacci and Dow’s Theory one step further was Ralph Elliott, an accountant who became ill and bedridden late in his life, and turned his attention to the stock market.  He formed a theory that consisted of five moves or “waves” upward, and three waves down.  The theory followed closely what Charles Dow had discovered nearly 50 years before, however Elliott now added the Fibonacci percentages to his analysis, allowing him to “predict” future turning points in the stock market based on the price action.

7: Candlesticks

Munehisa Homma was a very successful rice trader in Japan during the 1700s, generating over 100 billion dollars of profit in todays prices.  He formed a theory for trading and analysing the market which has become known as candlestick charting.  There are more than 20 candlestick “patterns” that evolve in the market, and many more ways to trade with them.  The main draw card for new traders and investors is the way the price is drawn, with a thick body coloured either black or white depending on which way the price closes.  As the picture shows, the bars look like candles, hence the name.

8: Highest Highs, Lowest Lows

While not so much a theory in itself, using a highest high of the last “x” days (or weeks, months) has been used independantly by many great and successful technical analysts, especially in the areas of Trend Following and Automatic Trading Systems.  Richard Donchian pioneered one method that used four week highs and four week lows to buy and sell.  William O’Neil of Market Wizards fame also used a 52 week high signal as a part of his trading and investing, all with great success.  Using highest highs is also very easy to program and optimize for automatic trading system use.

9: Relative Strength Index (RSI)

The Relative Strength Index is an “Oscillator” that is used to measure the rate of change in price.  It compares market up days and market down days within a specified period and indexes the results between 0 and 100.  The result is, over “x” periods, how many days finished with a closing price above the previous trading day compared to how many days finished with a closing price below the previous trading day.

People who use the RSI often use 30 and 70 as triggers for “oversold” and “overbought” levels.

10: Stochastic

The Stochastic indicator is a momentum oscillator that compares the latest closing price of a security to the lowest low and highest high over a given period.  The resultant figure is called %K, and is displayed as a solid line.  Then %D which is a 3 day Simple Moving Average of %K, and often used as a slow stochastic or as a basis for crossover signals with %K.

Like the RSI, the Stochasic will oscillate between 0 and 100, and levels above 80 or below 20 are often used as “overbought” or “oversold” levels.

11: Parabolic Stop And Reverse

The Parabolic SAR is a trend following indicator that is often used to identify entry and exit points, including a stop loss and trailing stop loss as the trade unfolds.  As the parabolic SAR moves up with the price it provides the perfect trailing stop loss.  Once the stop loss is hit, the Parabolic SAR reverses and now gives a stop loss on the top side of price.  The Parabolic SAR is useful in trending markets, and often used in trend following automatic trading systems.

12: Bollinger Bands

Invented by John Bollinger in the 1970s just as computers were making their way into finance, Bollinger Bands consist of a moving average, and then a moving average above and below it (usually “x” standard deviations above and below the middle moving average).

What this does is give a “band” that price often moves within.  If price is nearing or touches the top of the band, it is considered likely to fall to be back within the band.  Likewise, price nearing or touching the bottom of the band is considered more likely to rise to be back within the confines of the band.  Bollinger Bands also act as a volatility measure, naturally widening during times of high volatility, and shrinking during times of consolidation.

Read More On Fundamental Analysis | Read More On Chart Patterns | Read More On Trading Systems

What Other Technical Analysis Tools would YOU add?  What Do You Use?  What Works For You?

Leave your comments, questions or experiences in the comments section below.

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December 21, 2011  Tags: , , , , , , , ,   Posted in: Articles On Building Wealth, Market Analysis

4 Responses

  1. Irwin Scott - March 5, 2012

    CORRECTION TO 5, WHICH SAYS:-
    The numbers are found by adding the last two numbers in the sequence together, for example: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, and so on. Dividing these numbers by one gives you a series of percentages……

    NOT TRUE – SHOULD BE:-
    Dividing one by these numbers gives you a series of percentages

  2. Dave McLachlan - March 5, 2012

    Irwin Scott great pick up! Thank you.

    In fact it is even more complicated (and beautiful) than I remembered. If we divide a number by its predecessor we get the golden mean of 1.618, and multiplying the percentges by the golden mean is how they come to possible future turning points in the market.

    Article all updated, thanks to you.

    Cheers, Dave

  3. potla - September 30, 2013

    Good work, keep it up.

  4. Dave McLachlan - October 3, 2013

    Thanks potla 🙂

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