Technical Analysis Explained Trends in Technical Analysis Trend Classifications Support & Resistance Technical Analysis Indicators Using the MACD to trade the EUR/USD

1. Chapter 7:
Technical Analysis
Technical Analysis | Page #1

2. By definition, technical analysis is the analysis
of market generated data such as daily closing
prices and trading volume in order to identify
any patterns which can be indicative of future
price movements. For his market analysis, the
technical analyst can rely on price charts to
look for any discernible patterns.
Alternatively, he can also use technical
indicators to help him generate signals
indicating possible changes in the market
movements. Or it is entirely possible for him to
rely on a combination of charts and technical
indicators to help him analyze the markets.
Regardless of the approaches undertaken by
the technical analyst, the key factor is that he
still relies solely on market generated data for
his analysis.
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3. The legitimacy of technical analysis rests on 3 key premises:
• History will always repeat itself
The fact that history repeat itself meant that the analyst can look to
the past to see how the market will behave in the future given the
right conditions.
• Price movements in the market are in the form of trends
Since prices move in trends, the analyst can use the same patterns
to indicate that the market will behave in the same manner in the
future.
• The market price has taken into account everything
As the market price has taken into account everything, it is
pointless to analyze the prices to look for an intangible intrinsic
value in a particular asset.
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4. TRENDS IN TECHNICAL ANALYSIS
As mentioned above, one of the key
premises of technical analysis rest on the
assumption that prices move in trends.
By viewing price movements as trends, a
technical analyst is able to see the general
direction that the market is heading
towards at. Unfortunately for most people,
it is difficult to see numerical price data as
trend movements. The figure below
illustrates clearly the point that we are
trying to stress here. In the figure below,
you can see that the price data on the left
are represented as a candlestick chart on
the right.
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5. Hence, in order to have a better idea of how the prices are really behaving, most technical analysts prefer to view
their price data in the form of charts.
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6. TRENDS CLASSIFICATIONS
Trends can be classified into 3 categories namely uptrends, downtrends and horizontal trends. Uptrends are
characterized as having higher and higher successive peaks and troughs.
Downtrends, on the other hand, are characterized as having lower and lower successive peaks and troughs. As for
horizontal trends, they lack any well defined trends in any direction which why they are seen as moving sideways.
The importance of trends in technical analysis cannot be overstated because traders need to trade with the trend
and rather than against it.
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7. SUPPORT & RESISTANCE
Another important concept with technical analysis which you should take note of is the concept of support and
resistance.
The resistance level is defined as a price level or price range when current prices are having difficulties in breaching
upwards. Conversely, the support level is the price level or price range which current prices are finding it difficult to
drop under.
These levels are important to a technical analyst as they represent the thresholds which the market is galvanizing to
break through. They also represent the thresholds in the shift of market psychology which if having gathered enough
momentum will prompt the market to buy or sell. Once this shift has occurred, new support and resistance levels will
then be established.
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8. TECHNICAL ANALYSIS INDICATORS
To help signal technical analysts that the market conditions are ripe for a shift, they
rely on a wide array of technical indicators. Technicals are different from other tools
used by financial analysts due to the fact that they do not analyze any of the
fundamentals like the earnings or profit margin of a security. Instead, these
technicals are usually used for the analyzing of short term market movements and
pointing out not only potential for profits but signalling also if these opportunities
are likely to disappear.
COMMONLY USED TECHNICAL INDICATORS
Commonly used technical indicators include indicators like Bollinger Bands, Moving
Average Convergence Divergence (MACD) and Relative Strength Index (RSI).
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9. BOLLINGER BANDS
Bollinger Bands is a technical indicator that is used by analysts to measure the volatility of the markets which helps
to indicate if the market is overbought or oversold.
Higher volatility is indicated by wider bands while during periods of low volatility, the bands contract.
When the bands contracts, this by implication, mean that the volatility in the market is about to increase. As for the
indication for an overbought or oversold market, this is indicated by the way the bands manifested themselves on
the charts.
When prices start to move closer to the upper band, this mean the market is getting more oversold (undervalued).
Conversely, when prices start to move closer to the lower band, this shows that the market is becoming more
overbought (overvalued). All these signals are indications that the market is about to break out to a new high or new
low respectively. The chart above show prices breaking out to a new high (No.3 – Prices surges upwards).
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10. THE MACD INDICATOR
Another popular indicator used by analysts for their market analysis is the MACD indicator. The MACD is a trend
following momentum indicator that is derived from the relationship of two moving averages. Analysts typically use
the MACD to look for:
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11. CROSSOVERS
Sell signals are generated when the
MACD falls below the signal line and
conversely, buy signals are indicated by
the rise of the MACD above the signal.
The crossover point between the
MACD and signal line is taken by
analysts as confirmation that the
market has turned.
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12. DIVERGENCE
When there is a divergence
between the MACD and signal
line, this is indicative of a
trend coming to an end.
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13. DRAMATIC RISE
If there is a sharp rise in the MACD, i.e. the short term moving
average pulling away from the longer term moving average, this is
indicative of the security being overbought. What this implies is
that the price of the security will drop down to its equilibrium
point soon.
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14. THE RELATIVE STRENGTH INDEX (RSI)
The RSI indicator is normally used by analysts as confirmation of overbought or oversold market conditions. If the RSI
reading is heading towards 70, this mean the security is regarded as being overbought and will most likely pull back
soon. Oversold conditions are indicated by the RSI approaching a reading of 30.
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15. USING THEMACD INDICATOR TO TRADE THE EUR/USD
Let’s us put what we learn into practice. Let’s say we are interested in trading the EUR/USD currency pair. At this
point in time, we do not know the status of the market for the EUR/USD.
To find out if the EUR/USD is bearish of bullish, we turn to the MACD to give us this indication. With reference to the
chart below, we find that the EUR/USD is currently trading around the $1.276. The MACD shows that the market is
bearish.
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16. However, if we were to pay closer attention to the MACD indicator, we can see that MACD is about to
crossover. Looking back the past performance of the EUR/USD, we can see that the EUR/USD is due for
a crossover.
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17. As you can see from the transaction history below, we closed more in the money
than out of the money proving our assumption about the crossover is correct.
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18. Although the MACD indicator has helped us to predict which direction that the
market is likely to head to, it can sometimes give out conflicting signals as we
have seen above. It is only through our trading experience that we know we
should watch out for a crossover. Hence, for beginner traders, it is always best
to use more than one indicator to help you confirm the signals.
The above mentioned indicators are just some of the few commonly used
indicators by analysts and traders alike. To find out more about how to use
technical indicators in your binary trading strategies, please read some of the
trading strategies articles that we have posted in the anyOption’s 0-Hero guide.
You can download that here.
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19. Technical Analysis | Page #19