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Tuesday, December 8, 2009

Using Technical Analysis In Trading

By Michael Swanson

There are two major schools of thought among stock traders: one group strongly believes fundamental analysis is the only way to predict future price movements of a market instrument, while the second group is of the opinion that the best way is to use technical analysis.

The latter basically involves that you study past behavior in prices and trading volumes of a market instrument and then use that information to extrapolate future movements. The underlying assumption is that the past will repeat itself in the future, given the same set of circumstances. Proponents of fundamental analysis believe that this is not possible. Market conditions will never be exactly the same, so there is no way to use the past to predict the future.

The proof of course is in the pudding. There are indeed quite a number of traders making a sizeable income by using the tools of technical analysis in their trading activities.

These tools normally take the form of various charts depicting movements in prices and/or trading volumes. The chart types used most often are line charts, candlestick charts and Open High Low Close (OHLC) charts.

The data that is presented graphically fall into a number of categories. Examples of these are trend indicators, momentum indicators, volatility indicators and volume indicators.

Momentum indicators, e. G the RSI, fundamentally attempt to establish when the market has reached an 'oversold' or 'overbought' situation. If this happens it is highly likely that the price of that instrument is going to rise soon (oversold) or start dropping (overbought).

As their name implies, volume indicators analyze changes in the trading volume of a specific market instrument. A sudden change in price coupled with a simultaneous increase in trading volumes normally indicate that the market is responding to a strong stimulus and that the corresponding price movement could be quite large.

Volume indicators, as the name implies, study trading volumes over a particular period. If you notice a sudden increase or decrease in prices and volumes start to rise at the same time, it is a good indication that the market movement will be very strong.

Momentum indicators, a good example of which is the RSI, essentially try to determine when the market has reached an overbought or oversold position. If it's overbought, prices are likely to start falling soon and vice versa.

Studying the various tools of technical analysis will not only help you to predict future market movements, but will also give you valuable insights into the mechanics of the marketplace. - 23208

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