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A Brief Guide to Technical Analysis (Part 2)…

Line Charts and Bar Charts

Charts are primary tools used in technical analysis. They offer a visual aid to interpreting the trend and market action. With a chart, the old saying “A picture is worth a thousand words” is never more appropriate. There are different types of charts used to determine various aspects of the markets. In most cases, the x-axis measures the time while the y-axis measures the price level. These charts come either as line charts and bar charts.

Line charts are used to determine the closing price while bar charts represent the price performance for a specific period which could be as long as a month or as short as a minute. Daily bar charts are the most commonly used types of charts by traders.

The candlestick charts help traders determine what is most likely to happen in the movement of the market. These candlestick charts display the opening and closing prices as a solid body with the highs and lows as additional vertical lines. A candlestick shows the constant movements during the day, and so at what price people were willing to buy or sell. As with a technical analysis, the explanation of candlestick charts is based primarily on the patterns, which have been observed over several centuries as to how they can be used to forecast the price movement of a product. There are bullish patterns, bearish patterns as well as neutral patterns which indicate the movement in the markets.

Trend Lines

The basic trend line is a simple yet one of the most crucial tools in trading. The trend line is constructed where there are three higher or lower points which are to be connected. From this, a channel is outlined that can then be used to monitor the price action. When it comes to drawing a trend line, this involves some experimenting until the trader finds the right type. In some cases, a trend line which appears to be correct may actually need to be redrawn. For a trader who is getting started with trend lines, there are some useful guidelines that he needs to keep in mind in order to come up with the right one. With much practice, drawing trend lines becomes easier.

Trend lines come in many different motions and it is important for traders to understand the significance of these trends to avoid the risk of entering or exiting the market at the wrong time. There are two basic factors used to determine the significance of a trend line namely, the length of time it has been intact and how many times it has been tested.

Support and Resistance Levels

In technical analysis, support and resistance levels are one of the most essential components. Basically, these are price areas where an abundance of trading has taken place and where a great deal of buying or selling pressure is present. Underlying support keeps a market in an upward trend while overhead resistance keeps a market trend lower. These indications are used to manage risks and identify profit opportunities within the market.

Basically, a support level is the price area that calls for an increase in the demand for that product and resistance levels is a price illustrated by increased selling pressure or increased supply of a particular investment product which tends to level off advances.

Moving Averages

The moving averages are arguably the most reliable and practical technical analysis indicator. These are used to smooth out market changes as well as short term volatility which then help the trader determine which way the market is moving.  This is basically an indicator that shows the average value of a security’s price over a certain period of time. When interpreting a moving average, this is done usually by comparing the relationship between a moving average of the security’s price with the security price itself. A buy or sell signal is generated depending on the direction of the security price which can either be above or below its moving price.

There is also the case of multiple moving averages. While one moving average is a very useful tool in technical analysis, multiple moving averages can actually be more powerful when plotted on the same chart. Moving averages however work well in trending markets only. When a market changes in a slim trading channel, moving averages usually generate false signals.