Technical Analysis Basics

The principles of technical analysis are the study of price and volume, to help forecast the future stock price or financial price swings. It should also be noted that technical analysis does not result in absolute predictions about the future and is not an exact science. Instead technical analysis is an art and takes considerable experience. Not all studies work the same for every instrument traded. One study may give excellent buy and sell signals while another may not work for you at all.

Identifying A Trend

One of the most straight forward fundamentals is to identify the trend, which can be explained by the direction of the market due to supply and demand. Trends are not always easy to see, unfortunately. In fact, actually defining a trend can at times be rather complicated. You will 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. 

The diagram below is an example of an uptrend, where point 2 is a reference to the first high, which is determined after the price falls from this point. The 3rd point is the low that is established as the price falls from the high. If each successive low does not fall below the previous lowest point then the trend is regarded as an uptrend. If not, the trend is deemed as a reversal.

(Uptrend)                                                           (Downtrend)

Trendlines

Simply, 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. 

Looking at the above chart, an upward trend line 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. You can see how the price is propped up by this support. This particular trend line helps traders to pre-empt the point at which a particular stock's price will begin moving upwards again.

Similarly, a downward trend line is drawn at the highs of the downward trend. This line illustrates the resistance level that a stock faces each time the price moves from a low to a high.

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