Technical Analysis Tools
There are many technical analysis tools which include support and resistance, patterns and a very large number of indicators.
It is important for you as an investor to gain an overview understanding of the technical analysis tools that are available and then explore in more detail one or two tools that resonate with you.
This page is designed to provide you with a snapshot of some of the technical analysis tools. We encourage you to explore the linkes provided for more information.
- Tips for using technical analysis tools
- Support & resistance
- What is an indicator?
- Types of indicators
- Elliot wave theory & fibonacci
- Other Resources
When you use indicators or any technical analysis tool as part of your analysis, one very important point to remember is that they are derivatives of price action and any buy or sell signal should be taken in context with other technical analysis tools, as well as the underlying price action.
Here is a brief list of other simple tips for using technical analysis tools successfully in your investing or trading strategy:
Don’t search for the holy grail
Indicators highlight a particular aspect of price or volume behaviour and none are infallible. Support and resistance and patterns are the results of supply and demand in the market.
However, there is no one tool that will work in all market situations or conditions. For example trend indicators will lose money during a ranging market by whipsawing investors in and out of positions.
Keep in mind that tools will most likely be of the most value when used in situations appropriate for their use, combined with other technical analysis tools and with a goal of learning how to interpret them rather than using them mechanically.
Know your technical analysis tool
Study the behaviour of your indicator of choice or technical analysis tool and understand how it works and why it works. Learning to interpret charts is more of an art than a science. For example, the same indicator may display different patterns when applied to different stocks. Learn your tool's intricacies and by careful study and analysis you will develop expertise with technical analysis over time.
Keep it simple
Trying to use more than five indicators or tools to assist with your analysis is probably going to be futile and will more than likely result in a price chart where you can’t see the price action or where you are so confused by the various and differing signals that you don’t take any action at all (analysis paralysis!).
Choose a small number of tools, two or three at most, and use them to confirm signals from each other. There are hundreds of indicators but probably only a select few that offer different perspectives and these are the one that have been around the longest and stood the test of time.
Use contrasting tools
Try to choose indicators that complement each other instead of those that move in tandem or generate the same signals. For example, it would not be useful to use two indicators that both measure momentum and signal overbought and oversold conditions as exemplified by the Stochastic and the RSI indicators.
However, choosing three different tools that are based respectively on closing price, volume and a trading range will be more reliable when they do confirm each other.
Very simply a trend is the general direction in which a security or market is headed. An uptrend can be described as a series of higher highs and higher lows and a downtrend as a series of lower highs and lower lows.
One of the basic rules of investing is to trade with the trend so the ability to identify trends and also trend changes and use these for profitable advantage is important.
Identifying trends isn't always easy as prices don't generally move in a straight line.
Explore these resources for more detailed information on trends, trend lines and trend analysis:
Incredible Charts - a comprehensive coverage on trends, how to use them, their strengths and weaknesses and trend trading signals
Investopedia - part of a comprehensive tutorial on technical analysis, specifically focuses on trends and trend lines
Stockcharts.com - good explanations and examples of trend lines
Support and resistance are common terms that are used in technical analysis. They are a tool that can be used on their own or they can complement other tools and indicators. Support and resistance play a key part in the formation of chart patterns and old support can become new resistance (or vica versa).
What are support and resistance?
The price level at which buyers have historically shown a willingness to purchase.
The price level at which sellers have historically shown a willingness to sell.
Visit the following resources for further learning on support and resistance:
Incredible Charts - basic explanation with clear diagrams and examples
Stockcharts.com - detailed explanation with good examples
Investopedia - comprehensive tutorial on support and resistance
Chart patterns are formed by a combination of support and resistance and trendlines. Chart pattern analysis can be used in all timeframes. For example a triangle may form in a matter of days or a head and shoulders top may take months to form.
Patterns provide a framework to analyse the forces of supply and demand. They give a clear and concise picture and allow an investor to determine who is more dominant (buyers or sellers) so that they can position themselves appropriately.
There is a large amount of information availble on chart patterns. Here are just a few quality sites to get you started:
Incredible Charts - good overview then details on a range of long term, short term, daily and reversal patterns
Chartpatterns.com - basic explanations and diagrams
Investopedia - comprehensive tutorial on chart patterns
Stockcharts.com - chart school with a number of pages dedicated to chart pattern analysis
A technical indicator is a result of a mathematical calculation based on price data and/or volume.
In technical analysis, indicators are usually shown in graphical form above or below or even on a stock’s price chart and can be compared with the price chart of the stock itself.
Technical indicators can provide a different perspective on the strength and direction of the underlying price action and as such can be useful to the technical analyst. They can serve as an alert to the investor of the need to study price action a little more closely. For example, if momentum is declining this may be a signal to watch for a break of support.
Indicators can also be used to confirm other technical tools, for example a break of a chart price pattern might be confirmed by positive divergence of an oscillator.
There are hundreds of indicators available to the technical analyst. A brief overview of a few of the more widely used indicators is provided below.
A moving average is the most common and basic form of indicator and is one that calculates the average price of a security over a specified number of periods. Moving averages can help smooth the price action data to enable the investor to filter out the 'noise'.
Moving averages can help investors identify trends more easily. Different time periods can be used for different investing timeframes. Different forms of moving averages can also be applied and there are three main types simple, exponential and weighted.
Moving average convergence divergence (MACD)
More commonly known as the MACD, the Moving average convergence divergence indicator is one of the simplest and most effective momentum indicators available. Very simply, the MACD takes two trend following moving averages and converts them into a momentum oscillator by subtracting the longer moving average from the shorter moving average. As a result, the MACD combines both trend and momentum analysis. The MACD fluctuates above and below the zero line as moving averages converge, cross and diverge and signals can be generated by signal line crossovers, centreline crossovers and divergence. It is usually shown underneath price and is not a useful indicator for identifying overbought or oversold conditions.
The Stochastic indicator is a popular technical tool used to help monitor market momentum. As a general rule, momentum changes direction before price and therefore bullish or bearish divergences in the Stochastic can be used for identifying potential reversals. It is also useful for identifying when an instrument is overbought (meaning that prices have advanced too far too soon and theoretically are due for a downside correction) or oversold (meaning that prices have declined too far too fast and are theoretically due for an upside correction.
The Stochastic consists of two lines, a %K or fast line which compares the latest closing price to the recent trading range and a %D or slow line which is called the signal line and is calculated by smoothing the %K. Both lines are plotted on the scale between 1 and 100. Potential trigger lines are added to the Stochastic chart at the 20 and 80 levels to indicate potentially overbought or oversold conditions.
The chart shows the Stochastic lines underneath price action and the blue lines highlight the divergence – prices making higher highs but the indicator making lower highs, resulting in a change of trend.
Relative strength index (RSI)
The Relative Strength Index or RSI is also a momentum oscillator that measures the speed and change of price movements. It also identifies overbought and oversold conditions with its developer, J Welles Wilder considering these levels to be 70 and 30 respectively.
RSI compares upward movement in closing prices to downward movements over a selected period usually 7, 9, 14 or 21 depending on the timeframe of the investor. Here is an example of a chart showing overbought and oversold conditions.
Rate of change
The Rate of Change (ROC) oscillator measures the percentage price change over a given time period and the bigger the difference between the current price and the price of the of the specified time period the higher the value of the oscillator. When the indicator is above zero, the percentage price changes is positive or bullish and when it is below zero the percentage price change is negative or bearish.
On balance volume (OBV)
On balance volume measures the level of accumulation and distribution by comparing volume to price movement. Volume is added to the indicator if closing proice moves up and subtracted if closing price moves down. OBV can be used in either a ranging or trending market and like most indicators is best used in conjunction with other indicators.
Elliot wave theory is based on the premise that markets move in repetivie cycles or 'waves' and measures investor psychology. Elliot wave theory can be used to analyse current market structure and by understanding the wave patterns and learning the wave principles you can identify the highest probability move with the least risk. The theory is also closely aligned with the use of fibonacci ratios to determine retracement and price target objectives
For a more detailed look at Elliot wave Theory visit Elliot Wave International or for a basic explanation explore Investopedia's EW article. Stockcharts.com also have an excellent coverage of Elliot wave basics which is worth while reading.
There is a great deal of information on technical analysis tools available. The following are a few key sites where you can get further information:
ASX - Module 11 of the Shares Course covering technical analysis
Incredible Charts Indicators - comprehensive A-Z coverage of indicators, one of the best sites for all things technical analysis
Stockcharts.com Indicators - tutorial on various technical analysis indicators
Incredible Charts Technical Analysis - comprehensive tutorial on the practical applications of technical analysis
Investopedia Technical Analysis - comprehensive tutorial on technical analysis
Stockcharts.com Technical Analysis - comprehensive tutorial on technical analysis
Australian Technical Analysts Association - non-profit organisation dedicated to technical analysis