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Thread: Technical Analysis

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    Thumbs up Technical Analysis

    Introduction
    Technical analysis is research of market dynamics that is done mainly with the help of charts and with the purpose of forecasting future price development. Technical analysis comprises several approaches to the study of price movement which are interconnected in the framework of one harmonious theory. This type of analysis studies the price movement on the market by means of analyzing three market factors: price, volumes, and, in case of study of futures contracts market, of an open interest (number of open positions). Of these three factors the primary one for technical analysis is the prices, while the alterations in other factors are studies mainly in order to confirm the correctness of the identified price trend. This technical theory, just like any theory, has its core postulates.

    Technical analysts base their research on the following three axioms:

    Market movement considers everything
    This is the most important postulate of technical analysis. It is crucial to understand it in order to grasp rightly the procedures of analysis. The gist of it is that any factor that influences the price of securities, whether economic, political, or psychological, has already been taken into account and reflected in the price chart. In other words, every price change is accompanied by a change in external factors. The main inference of this premise is the necessity to follow closely the price movements and analyze them. By means of analyzing price charts and multiple other indicators, a technical analyst comes to the point that the market itself shows to her/him the trend it will most likely follow.
    This premise is in conflict with fundamental analysis where the attention is primarily paid to the study of factors, and later on, after the analysis of the factors, to conclusions as to the market trends are made. Thus, if the demand is higher than the supply, a fundamental analyst will come to the conclusion that the price will grow. Technical analyst, however, makes her/his conclusions in the opposite sequence: since the price has grown, it means the demand is higher than the supply.

    The prices move with the trend
    This assumption is the basis for all methods of technical analysis, as a market that moves in accordance with trends can be analyzed, unlike a chaotic market. The postulate that the price movement is a result of a trend has two effects. The first one implies that the current trend will most likely continue and will not reverse itself, thus, excluding disorderly chaotic movement of the market. The second one implies that the current trend will go on until the opposite trend sets in.

    The history repeats itself
    Technical analysis and studies of market dynamics are closely related to the studies of human psychology. Thus, the graphical price models identified and classified within the last hundred years depict core characteristics of the psychological state of the market. First of all, they show the moods currently prevailing in the market, whether bullish or bearish. Since these models worked in the past, we have reasons to suppose that they will work in the future, for they are based on human psychology which remains almost unchaged over years. We can reword the last postulate the story repeats itself in a slightly different way: the key to understanding the future lies in the studies of the past.

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    Timeframes:

    Regardless of the "timeframes" of the data in your charts (i.e., hourly, daily, weekly, monthly, etc.), the basic principles of technical analysis endure. Opportunities exist in any time frame. But customized settings of the technical analysis tools are needed for each time period.

    On the weekly chart, the scale interval on the time axis is one week. On the monthly chart, correspondingly, every bar shows price behavior for one complete month. It is obvious that in order to cover a longer period of time and to be able to analyze long-term trends, one has to compress the price behavior. A weekly chart, for example, can cover a period of five years and more, the monthly chart can cover twenty years or more. This is how the analyst manages to see far ahead of her-/himself and that is how s/he can assess the market in terms of the long-term opportunities, which are really valuable while conducting the technical analysis.

    The order of studying price chart is very important for deep analysis. It is wise to start by analyzing long-term charts and then move slowly to short-term charts. There is less "noise" on the long periods, that is why graphic models, basic trend lines and different levels of support or resistance are seen more clearly. This accounts for the type of work with data time periods. If we start studying short-term market, later on, as the volume of analyzed data expands, we will have to reconsider the conclusions several times at least. In the long run, short-term results may even change completely after long-term charts have been studied. If we start analyzing longer periods first, we can establish where the market is in terms of a long-term perspective. After that, we could then turn to chart studies which cover shorter periods of time. That is how an analyst goes from "macro" to "micro" analysis. At the final stage of the analysis, we determine the point of "entry into the market", i.e., the point of opening a position. The shorter the last analysis stage is, the more precisely one can determine this entrance point.

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    Line Studies
    In technical analysis, lines and various geometric figures to be plotted in price charts or in indicator charts are called line studies. Those include the Support/Resistance Lines and Trend Lines described above, along with:

    Fibonacci Tools
    Leonardo Fibonacci was an Italian mathematician born 1170 AD. He is considered to have invented numerical series during his studies of Great Pyramid of Giza. Fibonacci Numbers are a numeric sequence where each next number can be got by adding the last two ones: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.

    These numbers are interrelated with a series of curious correlations. For example, each number in the series is approximately 1.618 times more than the previous one, and each preceding one makes approximately 0.618 of the consequent one.

    There are several widespread instruments of technical analysis based on Fibonacci Numbers. The general interpretation principle of these instruments consists in the fact that, when the price approximates to lines built with their help, the changes in trend development should be expected.

    Fibonacci Arcs

    Fibonacci Fan

    Fibonacci Retracement

    Fibonacci Time Zones

    Fibonacci Expansion

    Fibonacci Channel

    Gann Tools
    W.D. Gann (1878-1955) developed a number of unique methods of price chart analysis. He paid the most attention to geometrical angles reflecting the interrelation between the time and the price. Gann believed that certain geometrical figures and angles have specific features to be used for forecasting price dynamics.

    Gann considered that there was an ideal ratio between time and price if the price grew or fell at an angle of forty-five degrees to the time axis. This angle is designated as "1х1" and corresponds with unit price increase for each unit time interval.

    Gann Fan

    Gann Line

    Gann Grid

    Other analytical tools
    There are line studies being largely used in technical analysis and helping to define channels and trend changes. These instruments are:

    Linear Regression Channel

    Equidistant Channel

    Standard Deviation Channel

    Andrews` Pitchfork

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    Fibonacci Arcs
    Fibonacci Arcs are built as follows: first, the trend line is drawn between two extreme points, for example, from the trough to the opposing peak. Then three arcs are built having their centers in the second extreme point and intersecting the trend line at Fibonacci levels of 38.2, 50, and 61.8 per cent.

    Fibonacci arcs are considered to be potential support and resistance levels. Fibonacci Arcs and Fibonacci Fans are usually plotted together on the chart, and support and resistance levels are determined by the points of intersection of these lines.



    It should be noted that the points of intersection of Arcs and the price curve can change depending on the chart scale since an arc is a part of a circumference, and its form is always the same.
    Last edited by worlddreem; 05-07-2007 at 10:24 PM.

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    Fibonacci Fun
    Fibonacci Fan as a line instrument is built as follows: a trend line — for example from a trough to the opposing peak is drawn between two extreme points. Then, an "invisible" vertical line is automatically drawn through the second extreme point. After that, three trend lines intersecting this invisible vertical line at Fibonacci levels of 38.2, 50, and 61.8 percent are drawn from the first extreme point.

    These lines are considered to represent support and resistance levels. For getting a more precise forecast, it is recommended to use other Fibonacci instruments along with the Fan.


    Last edited by worlddreem; 05-07-2007 at 10:10 PM.

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    Fibonacci Retracement
    Fibonacci Retracement are built as follows: first, a trend line is built between two extreme points, for example, from the trough to the opposing peak. Then, nine horizontal lines intersecting the trend line at Fibonacci levels of 0.0, 23.6, 38.2, 50, 61.8, 100, 161.8, 261.8, and 423.6 per cent are drawn. After a significant rise or decline, prices often return to their previous levels correcting an essential part (and sometimes completely) of their initial movement. Prices often face support/resistance at the level of Fibonacci Retracements or near them in the course of such a reciprocal movement.




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    Fibonacci Time Zones
    Fibonacci Time Zones is a sequence of vertical lines having Fibonacci intervals of 1, 2, 3, 5, 8, 13, 21, 34, etc. Significant price changes are considered to be expected near these lines.

    To build this instrument, it is necessary to specify two points to determine the length of a unit interval. All other lines are built on




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    Fibonacci Expansion
    Fibonacci Expansion is largely similar to Fibonacci Retracement and intended for determining of the end of the third wave. Unlike Fibonacci Retracement, this instrument is built not on the only one trend line, but on two waves.

    First, the line of the first wave is drawn, its height will be considered as a unit interval later on. The end of the second wave serves as a reference point for building an invisible vertical line. The corresponding lines are drawn from the reference point on the interval equal to 61.8, 100%, and 161.8 per cent of the unit interval. The third wave is considered to finish near these levels



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    Fibonacci Channel
    Fibonacci Channels are built using several parallel trend lines. To build this instrument, the channel having the width taken as a unit width is used. Then, parallel lines are drawn at the values equal to the Fibonacci Numbers, beginning with 0.618-fold size of the channel, then 1.000-fold, 1.618-fold, 2.618-fold, 4.236-fold, etc. As soon as the fifth wave finishes, correction in the direction opposite to the trend can be expected.

    It is necessary to remember for a correct Fibonacci Channel building: base line limits the upper part of the channel when trend is ascending, and the lower part of it when trend is descending.




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    Gann Fan
    Lines of Gann Fan are built at different angles from an important base or peak at the price chart. The trend line of 1х1 was considered by Gann the most important. If the price curve is located above this line, it is the indication of the bull market, if it is below this line it is that of the bear market. Gann thought that the ray of 1x1 is a powerful support line when the trend is ascending, and he considered the breaking this line as an important turn signal. Gann emphasized the following nine basic angles, the angle of 1x1 being the most important of all:

    1х8 — 82.5 degree

    1х4 — 75 degree

    1х3 — 71.25 degree

    1х2 — 63.75 degree

    1х1 — 45 degree

    2х1 — 26.25 degree

    3х1 — 18.75 degree

    4х1 — 15 degree

    8х1 — 7.5 degree




    The considered ratios of price and time increments to have corresponding angles of slope in degrees, X and Y axes must have the same scales. It means that a unit interval on X axis (i.e., hour, day, week, month) must correspond with the unit interval on Y axis. The simplest method of chart calibration consists in checking the angle of slope of the ray of 1х1: it must make 45 degrees.

    Gann noted that each of the above-listed rays can serve as support or resistance depending on the price trend direction. For example, ray of 1x1 is usually the most important support line when the trend is ascending. If prices fall below 1х1 line, it means the trend turns. According to Gann, prices should then sink down to the next trend line (in this case, it is the ray of 2х1). In other words, if one of rays is broken, the price consolidation should be expected to occur near the next ray.

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    Gann Line
    Gann Line represents a line drawn at the angle of 45 degrees. This line is also called "one to one" (1x1) what means one change of the price within one unit of time.

    According to Gann’s concept, the line having the slope of forty-five degrees represents a long-term trendline (ascending or descending). While prices are above the ascending line, the market holds bull directions. If prices hold below the descending line, the market is characterized as a bear one. Intersection of Gann Line usually signals of the basic trend break. When prices go down to this line during an ascending trend, time and price become fully balanced. The further intersection of Gann Line is the evidence of breaking of this balance and possible changing the trend.





    It is necessary to define two points for building a Gann Line.

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    Gann Grid
    Gann Grid represents trends built at the angle of 45 degrees (Gann Lines). According to Gann’s concepts, a line having a slope of forty-five degrees represents a long-term trendline (ascending or descending). While prices are above the ascending line, the market holds bull direction. If prices hold below descending line, the market is characterized as a bear one. Intersection of the a xhref="../gann_line">Gann Line usually signals of breaking the basic trend. When prices go down to this line during an ascending trend, time and price become fully balanced. The further intersection of Gann Lines is an evidence of breaking of this balance and possible change of the trend.





    To build a Gann Grid, it is necessary to define two points determining sizes of cells

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    Linear Regression Channel
    Linear Regression Channel is built on base of Linear Regression Trend representing a ussual trendline drawn between two points on a price chart using the method of least squares. As a result, this line proves to be the exact median line of the changing price. It can be considered as an equilibrium price line, and any deflection up or down indicates the superactivity of buyers or sellers respectively.

    Linear Regression Channel consists of two parallel lines, equidistant up and down from the line of linear regression trend. The distance between frame of the channel and regression line equals to the value of maximum close price deviation from the regression line. All price changes take place within Regression Channel, where the lower frame works as support line, and the upper one does as resistance line. Prices usually exceed the channel frames for a short time. If they keep outside of the channel frames for a longer time than usually, it forecasts the possibility of trend turn.




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    Equidistant Channel
    Equidistant Channel represents two parallel trend lines connecting extreme maximum and minimum close prices. Market price jumps, draws peaks and troughs forming the channel in the trend direction. Early identification of the channel can give a valuable information including that about changes in the trend direction what allows to estimate possible profits and losses. It is necessary to give the direction of the channel and its width to build the instrument.


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    Standard Deviation Channel
    Standard Deviation Channel is built on base of Linear Regression Trend representing a ussual trendline built between two points on the price chart using the method of least squares. As a result, this line proves to be the exact median line of the changing price. It can be considered as an equilibrium price line, and any deflection up or down indicates the superactivity of buyers or sellers respectively.

    Standard Deviation Channel consists of two parallel lines, equidistant up and down from the Linear Regression Trend. The distance between frame of the channel and regression line equals to the value of standard close price deviation from the regression line. All price changes take place within Standard Deviation Channel, where the lower frame works as support line, and the upper one does as resistance line. Prices usually exceed the channel frames for a short time. If they keep outside of the channel frames for a longer time than usually, it forecasts the possibility of trend turn.



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