When applying technical analysis to an underlying stock, the trader is attempting to discern price trend movements. Once a price trend is established it usually stays intact until a major catalyst appears that changes it. At this point prices usually move in a sideways or consolidating phase until the old trend resumes or a new trend commences. The pure technician doesn t care what the catalyst is and is free from all the facts and opinions surrounding the stock.
When first delving into technical analysis, it is important for the novice to first understand that technical indicators indicate, they do not dictate. The foundation of all technical indicators is based on the notion that markets repeat their patterns and that these patterns can be measured. It is important to realize when using technical analysis to gauge current conditions that there is only a probability, not a certainty that the pattern will be repeated. Essentially, technical analysis is all about probabilities when generating price forecasts.
Elliott Wave and Cycle Patterns
Most technical analysts in some form or another believe the market moves in cycles. Many of these analysts apply the Elliot Wave theory to the markets. The Elliot Wave theory is a price forecasting methodology described by Ralph Nelson Elliot in the mid-1930s. The theory asserts that a complete price movement has five waves, three aligned with the current trend, and two that are countertrend.
Long term waves that last for decades are made up of smaller waves that last for years. They in turn are made up of progressively smaller waves. The final waves last a minute or less, no matter the scale being applied, all Elliot Waves have the same characteristics and the rules for their behavior apply at all levels.
Cycle theory is a view of history that believes there is a certain order to the course of human events. In addition, this order can be mathematically measured or is in some other way inevitable and predestined. The events arise outside the boundaries of markets themselves, but are so powerful that they cause certain market behaviors.
The ability of technicians to forecast upcoming price movement behavior based on recent past price behavior is really not that great of feat if you stop and think about it. Market prices are a function of human behavior and human behavior tends to be repeated, whatever the time frame. For instance, a trader whose holding period averages 15 to 30 minutes will show the same behavior as a trader whose holding period is three weeks or one whose holding period is three years.
In addition, the exit point will be just as obvious on a 60-second chart, a monthly chart, or a two-year chart. Each time frame is exposed to the same rule of technical analysis and that is why it is so important for traders using technical analysis to use their own best time frame for investing.
Focusing on Current Price Trends
Regardless of how complex or simple you get when applying technical analysis, it is most important to focus on the current price trends. If you can consistently trade with the trend you have a higher probability of success in your trades over the long run. The old adage The trend is your friend is certainly true when using technical analysis stock software packages to uncover market opportunities.
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