Technical analysis uses past stock price data to predict future movements in prices of stocks or commodities. It involves using charts, tables and technical indicators to forecast the direction of prices. Before you use technical analysis tools for stock trading, it is essential that you first understand how various technical analysis tools work, what they measure and what they predict.
There are two types of technical analysis tools used by traders for stock trading; charts and indicators. Charts are created by compiling all relevant information, including daily high prices, low prices, opening price, closing price, highs and lows for specific periods. The graphical representation of this data shows how it has varied over time. It allows you to compare the close rate with that of previous days or months.
This makes it possible to analyze market conditions based on past patterns quickly. Indicators are mathematical formulas that process current market data such as open price, closing price and volume to predict future market movements. You can practice your technical analysis skills with Saxo.
What Are the Best Tools to Use in Australia?
The Moving Average
The moving average is based on the premise that markets move sideways for short periods before new trends begin. The fifty-day moving average tool predicts whether a stock’s price will rise or fall in the next five days by comparing it with its fifty-day past high/low. If the closing price is more significant than its fifty-day trailing, then the trend is up. However, if the closing price is less than its fifty-day trailing, then this signals that there might be downward movements in prices over the next five days.
A significant strength of this tool is predicting changing market conditions which are helpful when making quick investment decisions. For example, you can compare where a stock is in relation to its moving average and when the trending changes, you can make your decision quickly.
The Moving Average Convergence Divergence (MACD) Tool
The moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of prices. It uses two exponential moving averages; one with a more extended period and another with a shorter period. The MACD shifts the long term exponentially weighted average by subtracting the short-term one from it.
It offers traders more than just an indication of whether or not there is a trend in place; it also helps identify when trends start and end. Indicators such as this are helpful for decision-making; they provide information that’s not readily available through just charts, making it easier to buy or sell stocks. A further strength of this tool is predicting overbought and oversold situations. Once the MACD touches either of these two extremes, there’s an increasing probability of a trend reversal.
Bollinger Bands
Bollinger bands are volatility-based indicators that trader John Bollinger developed. They are used to help traders identify overbought or oversold conditions in the market and deviations from average market prices. They are created by drawing three lines on the price chart; the middle line represents the average price of a stock during a specific period, while the top/bottom lines represent standard deviations from the average price.
In a trending market, prices will remain between the bands and less volatile than in an uptrend. However, if a stock’s price falls outside of the bands, this indicates that it is oversold/overbought and is at risk for an upward/downward correction. This tool signals when volatility may cause erratic movements in the market, which are valuable indicators for assessing where stocks are likely to go next.
The Relative Strength Index (RSI) Indicator
The relative strength index (RSI) measures momentum on a scale of 0-100. It compares recent gains with recent losses to determine whether positive and negative effects are similar in magnitude. When RSI is high, it indicates that a share’s recent gains have been significant, which might mean its price will plateau soon.
Inversely, when RSI is low, the stock’s recent losses have been significant, meaning there might be upward momentum in prices in the near future. When RSI is at 50, it implies no momentum either way, and a reversal in a trend may occur. This tool signals when an uptrend or downtrend may end so traders can decide whether to sell or buy stocks accordingly.
