What to Understand in Technical Analysis?
In technical analysis, the aims are two-fold:
What is the price doing?
Where is the price going?
1. What is the price doing?
Market type: trending or ranging
Price volatility: quiet, normal, strong, fast, volatile
Hence, there are 13 market types looking at these classifications, namely:
Establish your system of market type identification. That is the first step in doing technical analysis.
There are various school of thoughts on market type. Among them are Elliot Wave Theory that looks at market fractals to identify cycle and Bollinger Band that identifies mean reversion value.
Market type identification gives us a structure on understanding price. It gives us understanding of trend strength, consolidation/distribution phase and overbought/oversold condition.
Build a strategy around one market type, instead of trying to build a strategy for all market type. In that way, one will have a specific standard operating procedures that work on a specific market type.
2. Where is the price going?
Equipped with market structure knowledge form market type analysis, a strategy builder can now move to the next part of technical analysis: the question of where is the price going.
Here, the goal is to identify price levels that are significant to market type.
Again, different methods are employed:
History of price movement: support & resistance, moving averages, patterns
Mean Reversion: Bollinger Bands, Keltner, Donchian
Indicators: Oscillators, Momentum
Having an understanding of price levels qive us knowledge of entry point & exit points. It tells us the quality of a setup and the actions to take when price reaches certain point.
In any technical system, the basic goals are:
1. Market type identification for the system
2. Simple entry method from the view point of setup quality
3. Complex exits method from the change of market type or significant levels/price pattern/market sentiment