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Technical Analysis Explained

Chart Types

Technical Analysis is the study of market action for the purpose of forecasting future price trends. The primary working tool is the chart. A chart is a graphical representation of price movement over a specific period of time and is composed (except for a few exceptions) of an x-axis (time) and an y-axis (price).

Figure 2

Figure 3There are different chart types frequently used:

Line chart: A line chart shows a line connecting the "closing prices". The closing is the last price recorded at the end of a specific period of time (session). The most commonly considered session is one trading day (daily close). (see figure 4) Other closings frequently used are the weekly close (end of the trading week) or the monthly close (end of the trading month). Especially short term traders establish their analysis also based on hourly line charts (close at the end of a 60-minutes period) or even 10-minute charts (6 closes within one hour).

The choice of the time frame employed depends on the user's need. It is obvious that an intra-day scenario will not be based on a monthly chart! A line chart, as well as some later on discussed charts too, can be plotted on an arithmetic or logarithmic scale. Especially, for a long term analysis on an item that shows a well defined up- or down-trend, users tend to apply a logarithmic scale. Figure 3 shows the difference between the two scales. On an arithmetic chart the distance from 2 to 4 (2 points move) would be the same as the one from 6 to 8. On the other hand, on a logarithmic chart, showing the move in terms of percentage, the distance from 2 to 4 (100%) is different to the move from 6 to 8 (33,33%).

Figure 4

Bar chart: Basically all characteristics mentioned for the line chart also hold true for the bar chart. However, the construction is a different one. The bar chart is composed of a high (highest price during a session), a low (lowest price during a session) and the close. All that is required is to draw a vertical line (bar) from the high to the low. Then, set a horizontal dot from the vertical line to the right, representing the close. Sometimes users refer also to the opening price; a dot drawn on the left side of the bar. The bar chart is probably the most popular chart in use today. (compare with figure 2)

Candlestick chart: The building blocks for the candlestick chart are the high, the low, the opening and the closing. The difference to the bar chart is that the open and the close form the cornerstones for the, so called, real body (see figure 5). The body is white if the closing is higher than the opening. The contrary is true for the black body.

Figure 5

The candlestick charting technique is an ancient Japanese invention dating from the late 18th century. The theory tries to unveil trend reversal or continuation signals. Various tools of analysis (moving average, RSI, trend-lines etc.) can be applied in combination with the candlesticks.

Figure 6Point and figure: The "point and figure chart" was created in the later 19th century and is roughly 15 years older than the bar chart. This technique tries to determine trends. A move is subdivided into price steps which size is determined in advance by the user. An upwards step is represented by an "x", a down-step by a "O". As a final parameter one has to choose the reversal criteria. It varies usually from one to three price steps. Example (see figure 6): Gold moves from 380 up to 392 and from there back to 385. The size of the price step is 1$, the "reversal criteria" is 3$. According to this we have to draw 13 "x's" up (end of up-trend). There 5 "0's" down (reversal criteria fulfilled with move back to 389; 3$ reversal).

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Vocabulary

A
Apex
Arithmetic scale
Art-charting
Ascending triangle

B
Bar-chart
Bearish engulfing pattern
Bottom-line
Bullish Consensus
Bullish engulfing pattern

C
Candle Stick /-chart 1, 2
Channel formation
Chart
Chartist
Closing prices
Complete cycle
Consolidation
Continuation formations
Contrarian Opinion
Corrective waves
Cycle lines

D
Descending triangle
Divergence
Daily close
Doji
Double top/bottom
Down-trendline
Dow Theory

E
Edge band analysis
Elliott-Wave
Engulfing pattern
Exponential moving average

F
Fibonacci-numbers
Fibonacci time zones
Five-wave
Four-weekly-rule
Flag
Fundamental Analysis

G
Golden section /ratio (phi)

H
Hammer
Hanging man
Head and Shoulder
High
Horizontal triangle

I
Impulsive waves

L
Larry Williams %R
Line-chart
Logarithmic scale/chart
Long term
Low
Low-risk entry point
Lunar cycle

M
MACD (moving average convergence/divergence)
"Markets Vane"
Medium term
Momentum
Monthly close
Moon cycles
Moving Average
M-Top

N
Negative or bearish divergence
Non-trending indicators

O
Oscillator
Opening

P
Peak
Pennant
"Phi"
Point and figure
Positive or bullish divergence
Price formation
Price objective
Psychological rationale

R
Rate of Change
Ratio
Real Body
Resistance
Rounding bottom/top
Relative Strength Index (RSI)
Reversal criteria/formation 1, 2

S
Saucer
Sentiment
Short term
Sideways trend
Simple Moving Average
Spiral Calendar
Stochastic
Stop-loss/Stop
Stop-profit
Support
Symmetrical triangle

T
Technical Analysis
Technical Analyst
Technical indicators
Three-wave
Time Cycles
Time frame
Timing
Top-line
Trading
Trading signals
Trend
Trending indicators
Trendline
Triangle
Trigger levels
Troughs

U
Up-trendline

V
Volume

W
Weekly close
Wedge
Weighted moving average
Whipsaw

Z
Zero line