GENERAL PRINCIPLES
Technical analysis is the study of market dynamics, most
often by means of charts, with the goal of forecasting of the future direction
of price development. The term "market dynamics" includes three main
sources of information that can be used by a technical analyst: price, volume
and open interest (as applied to the futures market). The price will mean
"thermodynamic" balance between the supply and demand for the
specific currency. And it does not matter what caused the balance: estimations
of macroeconomic parameters, recommendations of specialists, psychology of currency
traders or some other circumstances. Let us formulate three postulates on which
technical analysis is based:
The course (price) takes into account everything. Any factor
that influences the price (economic, political or psychological) has been already
considered by the market and included in the price. Thus, everything that
influences the price someway will definitely have an effect on this price.
Using price charts and many of their combinations, the market announces its
intentions to an attentive analyst that has a task to interpret these
intentions in the right way and time. The knowledge of this motivation of
market wishes is hardly required for correct forecasting. That is why
everything one needs for forecasting is just to study the price chart.
Price movement is subject to tendencies (price trends). The
main goal of making charts of price dynamics is to find the tendencies at early
stages of their development and to trade in accordance with their trends.
Directed movement of the price is called a trend.
Three types of trends (tendencies):
Up ("bullish" trend) – the prices go up
Down ("bearish" trend) – the prices go down
Sideways (flat, whipsaw trend) – no definite trend of
prices.
Three types of trends (tendencies) according to their
duration:
Long-term (main) – a trend with the term from 6 months to
several years.
Medium-term (intermediate) – a trend with the term from 2
weeks to 6 months.
Short-term (short) – a trend with the term up to 2 weeks.
Basic laws of price development:
The current trend in likely to keep than to change its
direction.
The trend will move in the same direction until it weakens.
Main types of charts
1. A linear chart – plots only the closing price for every
subsequent period. It is recommended for short time frames (up to several
minutes).
2. A bar chart – shows the highest price (upper point of the
bar), the lowest price (lowest point), the opening price (the dash to the left
of the vertical axis) and the closing price (the dash to the right of the
vertical axis). It is recommended for time frames of 5 minutes and longer.
3. A Japanese candlestick chart (is made on the analogy of
the bars). The rectangle between the opening price and the closing price is
called the candlestick, while the dashes from the candlestick to the high and
low prices at any given time frame are called shadow. The presentation is
similar to representation in bars. The candlestick with high > low is called
a bullish candlestick (White Day) and its body is filled in white (or green).
The candlestick with high < low is called a bearish candlestick (Black Day)
and its body is filled in black (red). The candlestick, where the open and the
close are approximately equal, and the high and low are very different, i.e.
the body of the candlestick has a small size as compared with the shadow are
called Doji.
4. A point and figure chart: does not have linear
representation of time, a new bar of prices is plotted after another trend appears
in the dynamics. A figure is drawn if the prices go down by a certain number of
points (reverse criterion), if the prices go up by a certain number of points,
a point is drawn.
5. Arithmetic and Logarithmic Scales. For some types of
analysis, especially if it concerns long-term trend analysis, it is useful to
utilize the logarithmic scale. In the arithmetic scale the distance between the
points is invariable. In the logarithmic scale, a similar distance corresponds
to similar changes percentagewise.
6. Volume charts.
DOW THEORY
Initially, the principles set forth by Charles Dow were used
to analyze the American indexes created by him, the industrial and railroad
industrial averages. But most of Dow’s analytical derivations can be equally
well used on financial markets.
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