“Technically the Market looks very Bullish”
“Technically there seems to be support coming in the market at current levels”
“The Technical Target for this trade is Rs. X”
“There is Marubozu Candlestick formation in the chart and we could see a reversal”
And Many More….
I am sure you must have heard these phrases in various news, forums, or social media channels and must have wondered what they mean. Is it some sort of Rocket science or something very difficult to understand? The simple answer to this is “NO”. Now through this article, we will break down the Myth and understand the various tools used in Technical Analysis by Traders for informed decision-making
“Technical Tools are various instruments, methods and strategies used by traders to make an informed decision making. Chats, Prices, Volume, and Market Trends are important tools used for Technical Analysis”
Traders often find themselves in the conundrum to shortlist the various tools that would make their trading system profitable and through this simple writeup we aim to introduce the various tools that would help you through this decision-making of choosing the right setup to trade.
Most Important Tools Used In Technical Analysis By Traders Consist Of
- Price Action
- Technical Indicators &
- Risk Management
1. Price Action
Although underrated, Price action is one of the most important tools that any trader should use if they intend on becoming a complete trader. Price action in simple terms is a method of understanding the ongoing trend or momentum in the market and spotting the Trade opportunities, without extensive use of technical analysis or any other trading Mechanism.
The Idea here is to pay attention to the market and also the ongoing price movements, understand the patterns and try to pre-empt the most likely move in the market. Price Action in a way is making sense out of what can be seen and also to try and foresee what could be the likely future price movement.
Any form of Buying and selling activity generates Price Action. Price Action could be as simple as watching the size of the ticket. If you see larger buy orders and smaller sell orders, then it can be deduced from there that the big players are more interested in Buying and we could see momentum on that side.
Various forms of Price action tools would include understanding Supports and Resistances, various forms of Chart formations, understanding of Trend Lines, trend formations (higher highs and higher lows and vice-versa)
This is another form of price action tool that traders use to gauge historical price movements and also to foresee and anticipate the probable movement of prices in the future. Sounds fascinating. Let us understand how is it done.
So, a candlestick has four major components. It plots the Open price, High Price, Low price & Close Price. Just by having a glance at the candlestick, you can understand the likely sentiment of the market.
There are generally four components of Candlesticks and they are abbreviated as OHLC. O signifies the Open price of the candle, H signifies the highest price of the candle, L signifies the lowest price of the candle and C signifies the closing price of the candle.
Now, if you look at the image above, we can see one Green candle and one Red candle. A green candle in general signifies Bulllishness or the end of Berish momentum in the market. And on the other hand, a Red candle signifies Bearishenss or a possible reversal of the existing bullish trend in the market.
There are generally two forms of Candlestick patterns that are being used by trades whilst making their trade decisions. The two forms are Single and Multi Candlestick patterns.
2.1 Single Candlestick Pattern
These are those patterns that get formed with the help of Single candlesticks. The Prior trend in the market has no bearing on the formation of this candlestick. And these patterns can be both bullish and bearish. Examples of single candlestick patterns include Marubozu, Doji, Hammer, Hanging Man, Spinning top etc.
For Example, if the ongoing trend in the market is Bearish and we see a formation of Bullish Marubozu (Open is the low of the candle and close is the high of the candle), then it is very likely that the market might turn bullish in the near future.
2.2 Multi Candlestick Pattern
A minimum of two candlesticks are required for the formation of the Multi Candlestick Pattern. The prior pattern here is of prime importance. This candlestick pattern is a combination of prior candles and they help us in pre-empting the future. And it can be also safe to say that the trade confirmation that one gets out of multi candlestick patterns is more reliable than single candlestick pattern. Example of Multi Candlestick Patterns includes Engulfing Patterns, Three black crows, Three white soldiers, Island Patterns, Morning star, Evening Star etc.
3. Technical Indicators
Technical Indicators can be called the backbone of any form of Trading activity. Indicators tell you about the existing sentiment or trend in the market and they also help in foreseeing the probable movement in future. Technical Indicators are a function of Price and Volume. Whenever we see movement in the prices and volume, we see the formation of Technical Indicators.
Technical Indicators formation on the chart also provides us with trade setups and trading opportunities. Technical Indicators are generally of two types – Leading and Lagging Indicators.
3.1 Leading Indicators
Leading Indicators are those indicators that provide us information about the probable moves in the market before the market actually makes a move. And because they are preemptive by nature, one should use caution while using them as they also have the tendency to provide false indications. But when the indicators are right about the probable moves, the trades tend to have a good risk-to-reward ratio. Some of the commonly used leading indicators include RSI (Relative Strength Index) and MACD (Moving Average Convergence and Divergence)
3.2 Lagging Indicators
Lagging Indicators are those indicators that provide us with lagging data. These indicators trail to the data provided by the price action. Lagging Indicators provide assurance to the already existing momentum in the market. In simple terms, it provides strength to the trend. Some of the examples of Lagging Technical indicators Include Moving averages, Bollinger Bands etc.
4. Risk Management
Rick Management is one tool that often gets neglected by the traders but it is the core element in trading as it ensures survival and also longevity.
Risk management is one tool that ensures that trades with proper risk-reward are been taken. As a trader, it is always advised to take trades with risk to reward in their favour. Say, if you take the trade with a risk to reward ratio of 1:1, you need to have an accuracy of more than 50% to be profitable over a long period of time. But on the other hand, if you have risk to reward ratio of 1:2, then even with an accuracy of a meagre 33% would make you break even and anything more than that would yield a reward.
Risk management also comes in the form of managing stop loss. Sometimes it is not a bad thing not to have a target for trade in mind, but a trade without a proper stop loss is a cardinal sin and one should avoid doing this.
Technical Tools are an important part of any trader’s journey. And a successful trader is able to get himself well versed with its various facets like Price action, Candlesticks, Technical Indicators, and Risk management. A journey to being a successful trader is not easy but discipline in your ways of management is a must to get there. That’s all for the article on Tools Used in Technical Analysis. We hope you found it useful.
Happy Trading and Money Making !!
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