Technical analysis deciphered: Five tools to enhance your trading Technical analysis deciphered: Five tools to enhance your trading Technical analysis deciphered: Five tools to enhance your trading

Technical analysis deciphered: Five tools to enhance your trading

Thought Starters 5 minutes to read

Saxo Bank

Summary:  Often considered the method of choice for more advanced traders, technical analysis provides a set of tools that all investors and traders could benefit from. In essence, it is the concept of interpreting market movements to better understand market sentiment, identify trading opportunities and managing risk.


From Japanese rice traders in the 17th century, the concept of technical analysis has since then evolved, and is along with fundamental analysis the leading schools of thought when investors analyse the future direction of financial markets.

Where fundamental analysis is made by examining the key ratios of a business, technical analysis is based on historical data from charts to see where the market is heading. When making an in-depth analysis it therefore makes sense to have both methods complementing each other instead of choosing one over the other.

“We can clearly see that technical analysis is increasing in popularity.”

“We can clearly see that technical analysis is increasing in popularity. Some rely solely on technical analysis in their trading endeavours whereas others use it as a supplement to fundamental analysis. Some tend to misunderstand what it is about, but technical analysis is very simple in its core, and is all about leveraging data to strengthen one’s risk management in terms of when to enter and exit a trade.” says Kim Cramer Larsson, technical analyst at Saxo Group.

The danger of falling in love with a trade

The market is over-flooded with information and it is human behaviour to filter out the stories that we do not like and place greater confidence in the sources we like. Adding this to the common tendency that many investors tend to follow a few companies or indices very closely results in an investor being inclined to fall in love with his position.

“It is very easy to take greater and greater risk when holding a losing position. And unfortunately, this often makes us change our investment horizon when holding a losing position hoping it will bounce back tomorrow. And to avoid the negative feelings of having a losing position we often add to that position to bring down the average price and thereby the loss in percentage. These actions are driven by emotions and can be eliminated by using some of the tools available from technical analysis to set a proper stop-loss that is integral to an investor’s approach to risk management,” says Kim Cramer Larsson. He has been studying investor psychology for years and sees many people making this exact mistake.

The importance of trends

When using technical analysis, observing trends is an important discipline. In short, a trend can be described as the general direction of the market during a specified time period. Trends can be both bullish and bearish, and the length may vary between hours and months. Utilising trends can help investors piece together a full investment overview and give indications when to invest – and when not to.

5 technical analysis tools and how to use them:

Simple Moving Average

A simple moving average is a useful tool to analyse the trend of a security since it smooths out price movements and reduces ‘noise’. It is calculated by adding the closing price of a security for a distinct amount of time – usually 20, 50 or 200 days – and then dividing this total by that same number. A shorter amount of days will lead to more volatility.  When using a simple moving average, you look for the time when the two moving averages cross which is usually referred to as either a ‘death cross’ or a ‘golden cross’. While these can be used to identify an emerging trend, they are not the strongest signals as the simple moving average is a lagging indicator.

BULLISH SIGNAL:
The golden cross occurs when the 50-day simple moving average crosses above a rising 200-day moving average. This is considered a sign of a bullish market and a buying indicator. Here it is exemplified by the Tesla stock, where the golden cross occurred in the beginning of 2017 marking the starting point of a positive trend in the stock price.

BEARISH SIGNAL:
A death cross is when the 50-day simple moving average curve crosses below a falling 200-day moving average. This is a sign of a bearish market, which could indicate it is time to sell. In this chart, the 50-day average crossed below the 200-day line (in red) indicating a longer downward trend throughout the year. 

Trend lines

Knowing when to buy or sell can be difficult. Setting up trend lines is a way of developing indications on when to buy, and when to cut your losses. Trend lines are made by making a line from between two or more price points - either high points or low points - to draw the resistance and support line.

BULLISH SIGNAL:
The upper trend line is the resistance trend line. When the price breaks the resistance line, it could indicate a positive trend for that given instrument and signals a buy signal. In this example it would mean the NASDAQ 100 index would have to break through 8100.

BEARISH SIGNAL:
The lower price points form the support trend line. It is to set stop-losses or identify short opportunities. If an instrument suddenly breaks the support line, it is often a bearish signal and indicates a price where the investor would typically benefit from cutting the loss rather than holding onto a falling knife. In this example it would mean the NASDAQ 100 index crossing below 7600.

Relative Strength Index (RSI)

RSI is a momentum indicator ranging from 0-100 showing the relations between the latest movement in the market. This can help to indicate whether an asset is being overbought or oversold.

BULLISH SIGNAL: 
When the indicator is between 0-30, it means the asset is being oversold, meaning it might be time to buy up before the trend is turning. In the case of Tesla, which happened in May, when the RSI dipped below 30 before bouncing back up in the coming months.

BEARISH SIGNAL:
If the indicator is placed between 70-100, it shows the asset is being overbought. This means it might be the right time to withdraw before the trend turns. In the Tesla example, that is exemplified in July when the RSI went above 70, which marked a turn in trend.

Bollinger bands

Bollinger bands are used to follow market volatility and provide indicators on when to sell or buy. Bollinger bands consist of a simple moving average with one band above and one band below showing the standard deviation, indicating how prices are dispersed around an average value. As volatility either increases or decreases, the bands move along. If the volatility is high, the bands expand – and if the volatility is low the bands contract.

BULLISH SIGNAL:
A sharp move penetrating the upper band is usually a bullish signal. In this example the Tesla stock penetrated the upper band in October, marking the start of a bullish trend throughout the next month.

BEARISH SIGNAL:
If there is a sharp move towards the lower band, it is a bearish signal. In December, the Tesla stock penetrated the lower band. This indicated a bearish trend in the following months.

Volume

Keeping an eye on the trading volumes can indicate when the market is about to go up or down – giving insights on when to buy or sell. The volume increases when investors buy or sell a certain asset and decreases when it is not being traded. Price and volume always go hand in hand since there is no market without price movement, and there is no price movement without volume. Volume represents balance of supply and demand that moves prices up and down.

BULLISH SIGNAL:
When price and volume is rising, it is an uptrend confirmation and a bullish signal. 

BEARISH SIGNAL
If the price is rising but volume falling it indicates an imbalance in the market and is a sign of price exhaustion.

Technical analysis made easy

For many traders, chart analysis is a time-consuming task. However, because it is purely based on data points, it can be completely automated. Trade Signals by Autochartist is one of the leading software in the market, and it is seamlessly integrated in SaxoTraderGO.


Ideal for all types of traders, Trade Signals identifies both emerging and completed Support & Resistance, Chart and Fibonacci patterns across hundreds of instruments. Traders can use it for trade inspiration or simply to supplement their own technical analysis. It also helps them identify key levels for stop loss and take profit orders, providing a potential entry or exit strategy across various asset classes. Trade Signals is free for Saxo clients and readily available in SaxoTraderGO.

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.