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Technical Analysis Explained

The concept of trend

The market moves in trends. The trend is nothing other than the direction in which the market is moving. The movement or price development does not occur on a straight line but takes a kind of a zigzag shape that might be reminiscent of the silhouette of a mountain's flank. It consists of a series of successive peaks and troughs (figure 7). It is actually the direction in which the peaks and troughs are moving that constitutes market trend. Upwards, downwards and sideways ("trend-less" consolidation) are the three basic trend directions. Just as important as the direction of the trend is the corresponding time frame that we can break down into three categories.

Figure 7

A long term trend lasts at least 6 months, the medium term covers a time span from one month to a few months. Any trend lasting less than one month is labelled "short term". This classification, to a certain extent, is subjective and shouldn't be considered as a rigid definition. Keep in mind the fact that a market can be in an up-trend as a long term scenario but is currently pausing in a medium term consolidation (sideways) and therein the short term price is heading south (down). Conclusion: Don't miss to mention the aspect of time whilst talking about a trend!

Trendlines

An up-trendline is a straight line passing through the "rising" troughs of an up-move (as shown in figure 8). The minimum requirement for such a line to be drawn is two reaction lows where the second is higher than the first. The importance of a trendline is increasing with every additional touching point, confirming the trendlines value. The longer a trendline lasts the more significant it becomes. Too flat and too steep trendlines tend to be short-lived. We can say that the most stable trends approach the "45 degree-angle" (equilibrium between price and time). A reversal of the trend is indicated with a violation of the up-trendline. Such an event can be used as a selling opportunity. On the other hand, as long as the up-trendline is intact, it represents a "low-risk" buying area. Sometimes the trendline based on the zigzag lows can be drawn parallel through the tops resulting in a channel formation (figure 9). A rally to the top of an upward channel can be used as a selling opportunity.

Figure 8

Figure 9

Support and resistance

In a falling market, support is a price level where buyers enter the market or old sellers liquidate their shorts with enough force to keep prices from going any lower. In a rising market, resistance is a price level where sellers entered the market or old buyers liquidated their longs with enough force to keep prices from going any higher. Previous peaks and troughs are considered as resistance, respectively support (figure 10 & 11).

Figure 10

Figure 11

When the market is pausing in a consolidation (sideways trend), it is squeezed between resistance (top-line) and support (bottom-line - see figure 12). A break beyond one of these lines can be used to initiate a trade. In an upwards channel the bottom-line acts as support whilst the top-line is representing resistance.

Figure 12

As a general rule it can be said that in an up-trend the test to a support can be used as a buying opportunity. The same is true for a break of a resistance. In a downtrend, on the other hand, a resistance zone is considered as a selling area etc.

Once a resistance or a support is clearly broken, they change their function and become the opposite. A support becomes resistance, a resistance becomes support.

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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