When it comes to stock trading, there are not many gray areas. Most traders fall into one of two camps: In the one camp you find the fundamental analysts. They believe that the only way to predict tomorrow’s prices is by using fundamental analysis. In the other camp are the technical analysts who believe that technical analysis is the way to go if you want to know whether the price of a particular market instrument will rise or fall.
Technical analysis involves studying past movements in trading volumes and prices of a market instrument and using that information to try and predict future movements. Traders following this approach therefore implicitly believe that the market will repeat itself under a given set of circumstances. Their opponents believe that the market has no memory – there are no guarantees that it will ever repeat the same behavior twice.
You will find successful traders in both camps. This seems to indicate that both approaches could indeed work if applied consistently.
Charts form the main arsenal of the technical analyst. These charts are used to portray changes in a large number of so-called technical indicators. The most popular chart types used by traders are: OHLC (Open High Low Close) charts, line charts and candlestick charts.
There are mainly four types of technical indicators which are normally displayed graphically by using the above charts. These are volatility indicators, volume indicators, trend indicators and momentum indicators.
Some of the better known trend indicators are the numerous moving averages, Parabolic SAR and MACD. If you, like many traders, believe that you should always ‘trade with the trend’ these indicators will be of great help to you in determining when the market has moved into a trend.
Momentum indicators, such as RSI, basically try to determine when the market has become ‘overbought’ or ‘oversold’. When this happens, the price of that particular market instrument is likely to drop soon (overbought) or start rising (oversold).
Volatility indicators, such as the ATR (Average True Range), depict ‘normal’ price ranges graphically, so that a trader can easily see when the price breaks out of this normal range – which might indicate a major price movement.
Momentum indicators, a good example of which is the RSI, essentially try to determine when the market has reached an overbought or oversold position. If it’s overbought, prices are likely to start falling soon and vice versa.
Studying the various tools of technical analysis will not only help you to predict future market movements, but will also give you valuable insights into the mechanics of the marketplace.
Apply stock charts to next year. See my 2010 stock market forecast.