Technical Analysis: A Beginner’s Guide

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Technical Analysis is the type of analysis which is used to predict the prices through the study of the history of that asset, movement, behaviour and volume.

Technical Analysis delivers short term predictions of any security which has historical movement data.

It works on stocks, index, futures, options, commodities, and forex, etc.

People might wonder how stock prices tell the future movement of the price. The basic idea behind technical analysis is that people are emotionally connected to money. They buy and sell in similar patterns except for the experts.

CERTAINLY, TECHNICAL ANALYSIS IS BASED ON THE BEHAVIOUR OF THE PEOPLE IN BUYING AND SELLING, ON THE BASIS OF THAT, IT SHOWS US SIGNALS OF BUY OR SELL.

Technical Analysis is the type of analysis which has nothing to do with the fundamentals of the underlying asset, however, any fundamental movement could overtake the assumptions of predictions by technical analysis.

Technical Analysis is completely opposite to the Fundamental Analysis.

A trader should have a point of view of the stock he is going to trade. A point of view includes determining the direction of the stock, the risk involved in it, expected reward on the trade and the expected holding period.

Technical Analysis allows you to do all of the above, like examining risk, determining the entry and exit levels, etc. However, there are some plus and minus points in it.

Let’s see a scenario,

Consider you are roaming as a tourist in some city, you don’t know, after visiting few places, you are hungry and you came up to a series of food stalls, but there are so many that you cannot decide where to eat.

FIRST CASE:

You move to different stalls, taste something, see the ingredients, hygiene and other stuff, then decide which one is best. In this, you might eat good food, but there are so many stalls out there, so it would not be feasible for you to go towards each and every stall. So you visit 4 or 5 stalls and eat food.

SECOND CASE:

You just examine the crowd on different stalls by just standing, watching people’s behaviour. The crowd gives you the vibe that the stall might have good food. you may be right or you may not as the crowd can’t be right always.

In the first case, it is more like a Fundamental Analysis where you study only 4 to 5 companies but thoroughly.

In the second case, it is like Technical Analysis where you analyze trends, volumes, etc.

Technical Analysis is for short term predictions as long term predictions can be more accurate by doing Fundamental Analysis.

You would not make a big return in a short term trade unless you are extremely lucky. Try to get low returns multiple times when the chances arrive.

There might be times when you would be in a loss, keep the stop loss and book as it is also the part of the game and try to cover it on other trades.

Therefore Technical Analysis is a research technique where you take a view in the movement of the price by using, charts, patterns, etc. However there are flexibilities in it, as there would be different market conditions, so make assumptions according to the market.

STARTERS OF THE COURSE

The technical analysis works on any tradable asset. While there are variations in doing Fundamental Analysis of different assets.

Technical Analysis doesn’t care about the overvaluation or undervaluation. It works on only historical data such as price and volume, etc.

The market knows everything that’s why the stock falls or flies, as there is some internal information about to come in public. Therefore the movement of the price is not meaningless, As a technical analyst, you can derive trading signals from the price movements.

Keep in mind that the price moves in trends, herd mentality or whatever you say, but if some buying happens, it is pretty much possible that the trend of buying would go on for a couple of trading sessions.

In examining patterns and charts, we would use the Japanese Candlesticks which would represent the open, low, high and close on the chart.

The Japanese candlestick techniques are invented by Japan. It was used by a Rice Merchant named Homma Munehisa in the 18th century.

The candles in the chart are either bullish or bearish. They can be denoted by blue/green/white colour as a bullish candle and red/black colour as a bearish candle. Below is the pic of a candlestick.

Let’s understand some terms.

Candlestick used for Technical Analysis
LET’S SEE THE ANATOMY OF THE BULLISH CANDLESTICK:

The open: When the market opens, the first price on which the trade happens is the open price of that trading session.

The High: It is the highest price on which the buying happens in the trading session.

The Low: It is the lowest price on which the selling happens in the trading session.

Upper Shadow: The upper shadow is an area of a bullish candlestick which is connected by the high and close.

Lower Shadow: The lower shadow is an area of a bearish candlestick which is connected by the low and open.

Real Body: The Real Body is the central part of the candlestick which is in between the open and close.

The Close: It is the closing on which all the trading activity ends on that session. It is an important value as we can assume that the final hands alleged to be the expert hands were bullish or bearish at the time of closing duration. If the closing price is above the opening price it is considered as a positive day otherwise negative.

Bearish Candlestick Anatomy

The bearish candle anatomy has similar meanings except for upper shadow and lower shadow.

UPPER SHADOW: IN BEARISH CANDLESTICK, THE UPPER SHADOW IS CONNECTED WITH THE OPEN AND HIGH.
LOWER SHADOW: IN BEARISH CANDLESTICK, THE LOWER SHADOW IS CONNECTED WITH THE CLOSE AND LOW.

Candlestick Chart

The above pic is a candlestick chart showing information in a set timeframe. you can see green candles as bulls and red as bears.

Technical charts are studied by using different time frames, some are as follows:

1.) Monthly

2.) Weekly

3.) Daily

4.) Intraday time frames

The investors generally use weekly and monthly charts while traders use daily/end of day charts.

Daily charts and Intraday time frames are widely used by traders.

In daily charts, there would be one candle for one trading session.

The open price will be at the opening of the trading session while close price will be at the time of the closing session. The high and low is in between.

Different intraday time frames such as 1 minute, 30 minutes, etc are used by ultra frequency traders. If you a consider a time frame of 30 minutes and you are watching the chart at 2 pm, the price at 2 pm will act as open an2:30 ppm as close with high and low in between this duration.

Use the different time frames accuse the type of trader you are.

HISTORICAL VIEW

Well, you have heard this a lot in different circumstances but it has certainly some weight in technical analysis. I have told that buying and selling occur in somewhat similar patterns. It is obvious that it would repeatedly happen. Hence we need to examine the history of the price of that security.

Let’s say, the stock is going up since 4 days consecutively, on the fifth day it faces some resistance to the upside however still manages to end the 5th days in green with low volume and volatility.

On the next day, the stock falls, assume there is no fundamental reason.

What if the above scenario happens again. let’s say today is the 5th days of the above pattern. we can clearly say based on the history of that stock that it would fall on the sixth day.

Hence, the historical view of the chart gives us the view of predicting the future price movements of that security.

Prediction based on the historical view of the charts is sheerly due to technical examination. there might be some fundamental factors or news which would influence the price regardless of its historical behaviour.

We would learn Fundamental Analysis in some other blog.

3 RULES FOR BEGINNERS

Everyone should remember these rules, before starting off let’s see.

3 Key Rules in Technical Analysis

1.) Buy when there is strength and sell when there is a weakness

When you buy, ensure that it is a green candle day. As bullish (green) candle means there is strength in the markets. there is a good possibility that it might go further. when you sell, ensure that there is a red candle day. As bearish ( red) candle means that there is weakness in the markets. There is a good possibility that it might go further down. Use a 1-day candle frame.

2.) Be flexible with patterns

I am going to tell you about the candlestick patterns, formations, and outcomes. Keep in mind that these are ideal conditions of the patterns. there may be less or more variations against the ideal conditions of the patterns. Be flexible with it and try to gain something by keeping some tolerance.

3.) Look for a prior trend

It is very important as it increases the probability of the predictions to be correct. If you see a bullish pattern and considering to go by the strength, make sure that the prior condition is bearish. If you see a bearish pattern and looking to sell, make sure that the prior condition is bullish.

Now we can learn about candlesticks.

DIFFERENT TYPES OF PATTERNS

We are going to look at candlestick patterns. these patterns are completely based on the candlesticks. Patterns form with single or multiple candlesticks.

First, let’s see single candlestick patterns as they can give very strong signals sometimes.

1.) Marubozu (Bullish and Bearish)
2.) Doji
3.) Spinning Top
4.) Paper Umbrella
5.) Hammer
6.) Hanging Man
7.) Shooting star

Multiple candlestick patterns are the combination of two or more patterns, here is the list of multiple candlestick patterns.

1.) Bullish Engulfing
2.) Bearing Engulfing
3.) Bullish Harami
4.) Bearing Harami
5.) Piercing Pattern
6.) Dark cloud cover
7.) Morning star
8.) Evening star

CANDLESTICK RANGE

In single candlestick patterns, the range is important. Singlestick candles are mostly used on the 1-day time frame. If the candlestick is read correctly and executed in the same way, we can get great benefits with this pattern.

One needs to see the length of the candles as they give us info about the volatility in that 1 day. If there are long candles, it shows us that there is heavy buying and selling happened in it. If the candlestick lengths are low it shows that the activity was restricted in that range.

There if you are a trader, you should avoid taking trading decisions based on short candles. As there might be further low volatility. which will not give you opportunities to square off with a good profit.

You can see the length of candlesticks in the above image.

Marubozu

Marubozu is a single candlestick pattern which forms anywhere irrespective of the trend. It is a Japanese word which means ‘the round part’.

We have seen the 3 rules, however, it does not consider the third one. Marubozu can be formed anywhere, we do not have to see the prior trend.

The marubozu candle does not have any upper shadow or lower shadow. Which makes the shape of the candlestick to be round. The bearish marubozu is the red coloured one while the bullish marubozu is the blue or green coloured one.

THE BULLISH MARUBOZU

When a candlestick has no upper shadow and lower shadow, including the open price = low and closing price=high. then the bullish marubuzo forms.

The bullish marubozu implies that people have bought on every price of the candlestick. There is so much buying interest that the closing price is the day’s high.

We don’t have to look for a prior trend as whatever it may be, now the sentiment is changed. It is expected that the bullish sentiment will continue over the next trading sessions. Therefore we can take a buy position here. Take the position when the candle is complete or there is less time left for the trading session to end.

Bullish Marubozu Example

In the above pic, you can see a bullish marubuzo formation. You can see the bullish marubuzo candle in the circle. Open=904, Close=921, High=922, Low=903.93

Here you can clearly see that the candle is not in an ideal condition of a bullish marubuzo. As there is slight variation in the Close and High. But still, it would be considered as a bullish marubuzo candle. As I have told you the second rule i.e. be flexible. The trade should be a buy at 922 and the stoploss would be 904.

Bullish Marubozu Example

LOOK OUT THIS ANOTHER EXAMPLE.

In the above pic, you can see a bullish marubuzo formation. If you see the price did go up after the bullish marubuzo formation. But it went down and you can clearly see that it had broken the low of the bullish marubuzo. that should be your stoploss.

Bullish Marubozu Example

one more example of bullish marubozu.

RISK TAKER AND RISK AVERSE

There are two types of trader, Risk Taker and Risk Averse. Risk Taker is more greedy and Risk Averse are less greedy.

Suppose If you want to buy a Tata Steel stock according to bullish Marubozu. But first you need to validate that the bullish marubozu has occured. You can do that by seeing if before 10 minutes of the closing session of trading. The low of the day is approximately equal to the opening price and the high of the day is equal to the current market price or not. If it happens then you can take a bullish trade. This type of trader is a Risk Taker.

However, Risk Averse is that type of trader who lets the candlestick to complete. He determines that the bullish marubozu has formed and take the trading position on the next day.

Risk Averse is completely sure that the bullish marubozu has formed while in case of Risk Taker. It might happen that in last 10 minutes that the price might go down because of the panic selling resulting in no bullish marubozu formation.

Risk Averse also has to take a deep stop loss against the Risk Taker. As he is carrying out his trading position on the next day.

STOPLOSS IMPORTANCE

In bullish marubozu, the open price working as a day’s low approximately is the stop-loss according to the textbook.

Stop loss is used to avoid further downfall from your trading position. however, the price may touch the stop loss and reverse back upwards. This happens but you have to stick to the rules. Get out from the trade if the price breaks the low or opening price of the bullish marubozu.

Let’s take an example, there is a stock which has, high:100, low: 95, open: 95.1, close: 99.8

Here, if you buy at 95.1 and the stock moves up to 100 but fails to sustain and comes down. Here the stop loss would be 95. If it touches the stoploss, you should exit from the position.

Stoploss Importance Example

In the above pic, you can see a bullish marubuzo candle. but despite that, the price broke the low of the pattern. Therefore Stoploss is used to limit your losses. If greed is restricting you to book your loss, you should stick to the discipline.

Remember, in any trade, you should either book loss or profit if the price touches the target or stoploss. We will study the target in the next article.

THE BEARISH MARUBOZU

Bearish marubozu is the candlestick which has no upper body and lower body. The open price is approximately equal to the high and closing price is approximately equal to low of the candlestick.

This candlestick pattern indicates that people have sold each and every moment of the price, such that the price closed at the day’s low.

Therefore one should sell after seeing the bearish marubuzo as the sentiment has changed now. No matter what the prior trend was, now the sentiment has changed.

For example, A stock has,
High: 100, Low: 95.4, open: 99.8, close: 95

The above is the specification of bearish marubozu. Therefore, we should sell at 95, and the stop loss should be the day’s high that is 100.

Bearish Marubozu Example

In the above pic, you can see a bearish marubozu formation. Here the open=high=948 and low=close=928.

The pattern suggests us to sell at 928 and the stoploss would be the high price.

THE SPINNING TOP

The Spinning top is a type of candlestick which has a small real body, the upper and lower shadow are almost equal.

This type of candlestick does not give signals to the direction of the stock price. It shows that there is a tug of war between the bulls and bears, resulting in indecision in the market. You can take your stance in the market by seeing this candlestick and the present market scenario.

A SPINNING TOP CAN BE GREEN OR RED CANDLE AS THE RANGE AND SHADOW OF THE CANDLE ARE ALMOST EQUAL.

Small real body:

Suppose there is a candlestick with open of 99 and close of 100 or open of 100 and close of 99, both these conditions would make a really small body. As the open and close of the candlestick is really close to each other it doesn’t matter, if the colour of the candle is green or red.

The upper shadow:

The high and close are connected to each other is a green candle. The high and open is connected to the red candle. If we ignore lower shadow and consider this upper shadow we can say that the bulls tried to take the price up, but they weren’t successful in this, resulting in a short candle, if they were successful in it there would be a long green candle.

The lower shadow:

The low and close are connected to each other in a red candle. The low and open is connected in a green candle. If we ignore the upper shadow and consider this lower shadow we can say that the bears tried to take the price down, but they weren’t successful in it, resulting in a short candle. If they were successful there would be a long red candle.

Both of them failed to move the market, therefore it is unclear to say where the price would move further, therefore one can take their stance in trading while seeing this candlestick.

THE DOJI

The Doji is a type of candle which does not have a real body at all, the open and close of the candle are equal. However The candle might have some real body but still, the open and close prices are close to each other. In this condition, we can still consider it as a doji, as I have already told you to be flexible.

It does not matter what the colour of the really small real body is, doji means there are uncertainty and indecision in the market.

Spinning tops and Dojis are similar and generally forms followed by each other.

Take your stance in this situation according to your benefit.

The Doji Example

In the above pic, you can see a Doji candle formation. You can see a doji and a spinning top, it appeared at the bottom of the downtrend then there is an uptrend followed by them. There is an equal chance that the market will go in any direction as the doji represents indecision in the market.

The Doji Example

In the above pic, you can see a Doji candle formation, where there is a downtrend after the doji and the spinning top formation.

THE PAPER UMBRELLA

The paper umbrella is a type of candlestick pattern where it consist of the small real body and long lower shadow, minimum twice the size of the real body.

The paper umbrella shows two trend reversal patterns named the hanging man and the hammer. When the paper umbrella forms after a bullish trend it is known as a hanging man. When the paper umbrella forms after a bearish trend it is known as the hammer.

THE HAMMER FORMATION

The bullish hammer forms at the bottom of the trend, such that the prior trend should be bearish however the hammer can be of any colour, it doesn’t matter, but it is more comforting if the colour of the hammer is green.

There can be a slight upper shadow but be flexible with it.

It works in such a way that,

When the markets are in the grip of bears. Every day the market opens lower compared to the previous close and making a new low every day.

When the hammer forms, the price go lower and make a new low. However, some buying happens and the bulls manage to close near the day’s high.

The buying interest shows that bull try to make a comeback and they were somewhat successful in it.
Therefore there is a good chance that a trend reversal might take place. Hence one should buy after seeing this candlestick pattern.

The Hammer Example

In the above pic, you can see a Hammer candle formation. Here you can see a trend reversal followed by it. You can see a slight upper candle but be flexible.

HAMMER TRADE SETUP

Hammer is used to taking long trades, If you are are a risk taker you can execute the trade before the 10 minutes before the closing session. No matter what the colour of the real body is, but the lower shadow should be longer than twice of the real body.

If you are a risk-averse, you can take the bullish trade after seeing that the pattern is completely formed and carry out the trade on the next day. Here, Risk Averse is making sure that the trading session is ending on a green candle day.

The low of the hammer acts a stop loss.

The Hammer Example

In the above pic, you can see another Hammer candle formation example.

THE HANGING MAN

When a paper umbrella forms at the top of a bullish trend, it is known as ‘Hanging Man’. The prior trend must be bullish, then only the candlestick pattern is a Hanging Man.

It doesn’t matter what is the colour of the real body, as far as the lower shadow is double in length, we can say that a candlestick is a hanging man.

It works in such a way that,

When the market is in an uptrend, the market is making higher lows and new highs.

The market is completely in the bulls control. But when the hanging man appears on that day, Bears try to make an impact and creates a long shadow.

Therefore we can say that bears are trying to break the momentum of the market, hence we can take a sell position after seeing the hanging man.

The Hanging Man Example

In the above pic, you can see a Hanging Man candle formation. It appeared after the uptrend and the downtrend followed by it.

THE HANGINGMAN SETUP
Trade Set up:

If you are Risk Taker, you can initiate your trade before the 10 minutes of the closing of the session, you can sell by getting the assumption that the hanging man is formed.

If you are a Risk Averse, you can wait for the candlestick to complete and become sure, then initiate your trade on the next day.

The high of the candlestick works as a stop loss.

It is my personal view that, if the bears were successful in taking the market lower in the hanging man candlestick but why did the market manage to end on a bullish note. It means bulls tried to regain their momentum and they were successful in it.

THE SHOOTING STAR

The shooting star is an inverted paper umbrella as it has an upper shadow and a smaller real body, in which the upper shadow is twice or greater than the length of the real body.

Shooting Star is a bearish pattern, the longer the upper shadow the more bearish is the pattern, A shooting star does not have a lower body in an ideal condition, however, a little lower shadow can be tolerated.

The shooting star works on the principle that,

When the market is in the uptrend, it makes new highs and higher lows. The market is in the grip of the bulls. When the shooting star pattern forms the market goes higher. But couldn’t sustain and the selling pressure takes the market down resulting in closing at the low point of the day.

Shooting Star Example

In the above pic, you can see a Shooting Star candle formation. you can see that if you went short on the closing price, it would be a successful trade.

TRADE SET UP:

When the candlestick is forming a shooting star, or it is implied that it would be a shooting star after closing. Then the Risk Taker can sell before the 10 minutes of the reading session.

However, Risk Averse can wait for the second day. They determine that the shooting star has formed and then can initiate the trade on the second day.

The stop loss would be the high of that shooting star pattern.

Shooting Star Example

In the above pic, you can see another Shooting Star candle formation. you can see a very small body with a long upper shadow.

FINAL WORDS

Technical Analysis does not guarantee your profits every time. It is a research technique which is used to guess the movement of the prices of the tradeable assets.

One should be flexible in different ideal conditions of the technical analysis. You will get to see the patterns with some variations.

Be flexible enough to modify and read the charts in order to improve the accuracy of the predictions.

Remember do not flow against the stream, always follow the trend in their initial levels.

I know people who say technical analysis does not work and I know some people who are profitable traders because of it.

We can do technical analysis by different indicators which we will learn in the next guide.

It is up to you how you analyze the charts and patterns according to your benefit.

Bullish Candlestick Specifications

Above is the anatomy of a bullish candlestick.

Specifications of a Bearish Candlestick

Above is the anatomy of a bearish candlestick. Take a look for revision.

Free website for technical analysis is listed below.

Tradingview

There are platforms provided by different online brokers for Technical Analysis.

Read: What are Futures and Options?

You can hear this podcast if you want.

https://m.soundcloud.com/technical-analysis-radio/sets/the-all-star-charts-podcast-on-technical-analysis-radio

Watch this video about 3 popular ways by which you can predict the movement of a stock price.

This article is in layman terms so that everyone can understand.

Please share this with your friends and connections.

About the author

Saifullah Khan

Hi there, I am the owner of gloomyworld.com, read more about me here.

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