How to Learn Technical Analysis: The Complete Guide for Beginners

Imagine you are on holiday in an unfamiliar country where everything, including the people, the language, the culture, the climate and the food, is new to you. After a busy day of sightseeing, you feel very hungry and want to end the day with a great dinner. You head to a famous food street nearby and decide to give it a try. (I know this may not seem to have much to do with today’s topic, technical analysis, but bear with me.)

To your surprise, there are dozens of stalls selling all kinds of food, and everything looks delicious. You have no idea what to eat for dinner and, to make your dilemma harder, you cannot ask around because you do not speak the local language. What should you do?

Option 1: You go up to a stall and find out what they are cooking and selling. You check the ingredients and the cooking style, and perhaps ask for a small taste (if you can) to see whether you really like the dish. You repeat this with several other stalls and restaurants, and then you will most likely eat at the place that satisfies you most.

The advantage of this approach is that you know exactly what you are eating, because you have researched it directly and carefully. On the other hand, the method does not really scale. You might succeed with a few dishes and a few stalls, but there is a good chance you will miss the best food.

This is typically how a fundamental analyst (Fundamental Analysis – FA) selects stocks. We study the things that appeal to us about a business: industry outlook, competitive advantage, financial position, management, earnings per share and so on, so that we can make the choice we are most comfortable with. If you do this work well you will rarely make mistakes, but you will also often miss good stocks.

Option 2: You stand in a corner and watch the people on the street, then stop at the busiest stall. The simple logic is: “This restaurant attracts the most customers, so it must sell the best food or offer the best service!” Based on your assumption about the crowd’s preferences, you decide to have dinner there. Chances are you will eat the best food available on the street, or be disappointed because the crowd’s taste does not suit yours.

The advantage of this method is that it can be applied at scale. You simply identify the restaurant with the most customers and bet that it is good based on the crowd’s preferences. That is exactly the approach of technical analysts (Technical analysis – TA): choosing “hot” stocks and following the trend of the market crowd. The risk of this method, of course, is that the majority is not always right.

What is technical analysis?

According to Wikipedia, technical analysis is an analysis method for forecasting the direction of prices by studying past market data, primarily price and volume. Technical analysis is a trading strategy that uses charts and statistics to analyse patterns in market data in order to forecast future trends.

Technical analysis is used to trade almost every type of financial asset, such as stocks, commodities, forex, futures contracts, options contracts and more. Unlike fundamental analysis, the tools of technical analysis carry the same meaning across every traded market.

What do you need to learn technical analysis?

Technical analysis studies many aspects of price and volume, and every analytical method and technique has its own strengths and weaknesses. Of course, you do not need to learn everything listed below to trade successfully, but having an overview of technical analysis helps you know where to start.

Dow Theory

This is considered the foundational theory of technical analysis, and many of its principles are still applied today.

Charting methods

There are many ways to represent price based on three variables: price, volume and trading time. The three most popular chart types today are:

• Japanese candlestick charts.
• Bar charts.
• Point & Figure (P&F) charts

Trendlines and price channels

• Support and resistance – Support is the area where buying returns and stops price from falling further; resistance is where sellers return and stop price from rising further.
• Trendlines: drawn by connecting successive peaks/troughs to identify the trend and potential resistance and support zones.
• Price Channels suggest effective buy and sell signals based on breakout points.
• Andrews Pitchfork: a trendline-based method for identifying potential future resistance, support and retracement levels.
• Parabolic Stop and Reverse (SAR): a tool that combines price and time to identify effective points for placing stop/stop-loss orders.

Basic Japanese candlestick patterns

• Candlestick Basics – If the close is higher than the open, the candle is considered bullish, and vice versa.
• Doji: a candle whose open and close are equal or very close, showing a balance between buyers and sellers.
• Marubozu: a candle with a long body and no shadows, usually showing that buying or selling pressure dominated one side of the session.
• Dragonfly Doji: a doji whose open and close coincide with the session high, with a long lower shadow.
• Gravestone Doji: a doji whose open and close coincide with the session low, with a long upper shadow.

Bearish reversal candlestick patterns

• Hanging Man: a single-candle bearish reversal warning that occurs mainly at the top of an uptrend.
• Shooting Star: a single-candle bearish pattern formed when the open, low and close of the session are nearly equal, with a long upper shadow.
• Bearish Engulfing – a two-candle pattern in which the second, bearish candle’s body completely engulfs the body of the first candle, showing strong selling pressure.
• Bearish Harami: a two-candle bearish reversal pattern in which the body of the first, bullish candle contains the body of the second, bearish candle.
• Dark Cloud Cover – a two-candle pattern with a bullish candle on the first day and a bearish second candle that covers most of the first candle’s body.
• Tweezer Top: a two-candle reversal pattern that appears at the end of an uptrend.
• Evening Star: a three-candle reversal pattern that usually appears at the end of an uptrend.

Bullish reversal candlestick patterns

• Hammer: a single-candle bullish reversal warning that occurs mainly at the end of a downtrend.
• Inverted Hammer: a single-candle bullish pattern formed when the open, low and close of the session are nearly equal, with a long upper shadow.
• Bullish Engulfing – a two-candle pattern in which the second, bullish candle’s body completely engulfs the body of the first candle, showing strong buying pressure.
• Bullish Harami: a two-candle bullish reversal pattern in which the body of the first, bearish candle contains the body of the second, bullish candle.
• Piercing Pattern: the opposite of Dark Cloud Cover.
• Tweezer Bottom: a two-candle reversal pattern that appears at the end of a downtrend.
• Morning Star: a three-candle reversal pattern that usually appears at the end of a downtrend. 

Chart patterns

• Double Bottom: a two-trough pattern that forms at a support zone at the end of a downtrend.
• Double Top: a two-peak pattern that forms at a resistance zone at the end of an uptrend.
• Head & Shoulders: one of the classic reversal patterns, with a high probability of success.
• Triangle: includes three forms – ascending, descending and symmetrical triangles.
• Flag: usually a continuation pattern that identifies buy/sell signals after price breaks out of a short consolidation zone.

Moving Average – Moving averages

• Simple Moving Average: considered the most popular technical analysis tool, commonly used to determine trend direction and generate potential buy and sell signals.
• Exponential Moving Average (EMA): a moving average that gives more weight to the most recent sessions.
• Adaptive Moving Average: becomes more sensitive when the market is trending strongly and less sensitive during sideways phases.
• Triangular Moving Average: a Simple Moving Average smoothed by an average of itself.
• Typical Price Moving Average: a combination of the Pivot Point and the Simple Moving Average.
• Weighted Moving Average: a moving average whose weights increase from the oldest to the most recent sessions.

Bands & Envelop

• Moving Average Envelopes: a moving average plus and minus a percentage set by the user.
• Bollinger Bands (BB): a combination of a moving average and the standard deviation of price.
• Keltner Channel: a combination of a moving average and the average true range (ATR) of price, used to signal possible price breakouts, show the trend and give overbought and oversold readings.

Index Indicators – indicators that measure the state of the market

• Arms Index (TRIN): a volume-based confirmation indicator that measures the trend and overbought/oversold zones.
• Average Directional Index (ADX): helps determine whether the market is trending and measures the strength of the current trend.
• Commodity Channel Index (CCI): a popular indicator for identifying buy and sell signals and overbought and oversold price zones.
• Directional Movement Index (DMI): consists of two lines, DMI+ and DMI-, which generate potential buy and sell signals.
• Money Flow Index (MFI): very useful for confirming price trends and warning of possible reversals.

Oscillators

• Chaikin Oscillator (or Volume Accumulation Oscillator): can be used to confirm price trends and detect divergences.
• MACD is built on the difference between a short and a long moving average.
• Rate of Change (ROC): compares price change over a number of sessions; used to confirm price moves or detect divergence signals.
• Momentum: based on comparing the current price with a past price. Very similar to Rate of Change.
• Relative Strength Index (RSI): measures trend strength by comparing price gains and losses over a given period.
• Stochastics (Fast and Slow): useful for detecting price divergence and confirming overbought/oversold zones.
• Stochastic RSI: an indicator that combines RSI and the Stochastic.

Volume indicators

• On Balance Volume (OBV): combines price and volume to confirm the price trend.
• Price Volume Trend: combines percentage price change and volume to confirm the strength of the price trend and warn of reversal signals.
• Volume Accumulation: combines volume and price weighting to determine trend strength.
• Volume Oscillator: built on the difference between two moving averages of trading volume.
• Volume Rate of Change: measures the percentage change in current volume relative to past trading volume.
• Accumulation Distribution: uses volume to confirm the price trend or warn of weak moves that may lead to a reversal.

Market Strength – indicators that measure the strength of the stock market

These indicators are designed specifically for the stock market: they measure the relationship between the number of advancing and declining stocks in a given market.

• Advance-Decline Ratio: used to confirm the trend of the broad market and detect divergence signals.
• Market Thrust: a measure of stock market strength based on internal market variables.
• New High – New Low Index: built on the number of stocks making new highs and new lows in a session.

Fibonacci ratios

• Fibonacci Retracements: the most widely used Fibonacci tool, based on three key Fibonacci levels: 38.2%, 50% and 61.8%.
• Fibonacci Arcs: a tool for identifying potential future resistance and support levels based on past highs and lows.
• Fibonacci Time Extensions: apply Fibonacci ratios to time.
• Fibonacci Fans: apply Fibonacci ratios to both price and time to anticipate when the market may top, bottom or reverse.

Elliott Wave Theory

A theory based on Elliott’s research showing that price moves in repeating wave patterns. It is widely used in modern technical analysis, although several aspects of its effectiveness remain controversial.

Setting the right expectations before using technical analysis

People often come to technical analysis thinking it is a quick and easy way to make money in the market. On the contrary, technical analysis is anything but quick and easy. Done well, it can of course deliver strong returns, but getting there takes a continuous process of learning and experience. So before you dig deeper into technical analysis, it is important to set reasonable expectations about what you can and cannot achieve with this approach.

• Technical analysis is best used to identify short-term trades. Do not use technical analysis to identify long-term investment opportunities; those are best identified with fundamental analysis. And if you are a fundamentally driven investor, use technical analysis to fine-tune your entry and exit points.
• Profit per trade – trades based on technical analysis are usually short-term in nature. Do not expect huge profits in a short time. The trick to successful technical analysis is to identify frequent short-term trading opportunities that can give you small but consistent profits.
• Holding period – trades based on technical analysis are held for anywhere from a few hours to a few weeks and usually no longer. We will explore this further when we discuss trading timeframes.
• Stick to your stop-loss – analysts usually enter a trade for a sound reason, but if the stock moves against them, losses cannot be avoided. In such situations, traders often tend to hold on to losing trades in the hope that they will recover. Again, remember that trades based on technical analysis are short-term: if price moves against your original view, cut the loss and move on to another opportunity.

Frequently asked questions about technical analysis

Is technical analysis based on science?

Technical analysis is built on foundations drawn from mathematics, behavioural psychology and economics. Mathematics is used to build quantitative forecasting models from price, volume and other market data. Behavioural psychology helps us understand the human behaviour that leads to buy/sell decisions. Economics describes how economies behave at the macro and micro level, which in turn affects long-term market price trends.

What is the difference between technical analysis and fundamental analysis? 

Technical analysis tools and techniques focus on identifying potential price movements, specifically the direction and strength of the trend and the likelihood of further price moves. Fundamental analysis is designed to gain deep insight into a stock’s overall condition in order to determine its intrinsic value relative to the current market price.

Which technical indicator is the best?

Every technical indicator has its own strengths and weaknesses. The best technical indicator is the one that suits you best: one whose nature you understand and that helps you trade profitably.

I hope you will soon find the indicators that suit you and build your own trading system, with the help of the detailed articles on each type of technical indicator below.

Technical Analysis Course – CMT Level 1

Green Chart designed this course specifically for candidates in Vietnam who want to study and prepare for the CMT Level I exam. The programme includes 27 sessions of theory, practice questions and mock exams. Students also receive the course textbook, question bank and mock exams free of charge for their exam preparation, and can retake the course for free for life.

See more details about the course here.

Happy trading !