Unlike fundamental analysis, technical analysis focuses on price movements, helping investors identify trends and market entry points more effectively and accurately. There are two prominent methods in stock technical analysis: trading by price action and trend following.
1. Trend following in technical analysis:
a. What is a trend?
A trend is a directional movement of prices over time. Time frames are typically divided into three types: short-term (under one year), medium-term (1-3 years), and long-term (over three years). Technically, a trend will reflect the intention of the money flow entering the stock.
b. What is the trend following?
Trend following is commonly used by investors when trading on financial markets in general. This method allows investors to recognize and exploit the main trends of the market to make investment decisions in the short and long term.
c. Three common types of trends in technical analysis:
Technical analysis has three primary trend forms: upward, downward, and sideways.
- Upward trend: An upward trend in stocks shows the intent to maintain buying among investors with significant money in the stock. A trend is formed when prices create higher highs and higher lows.
- A downward trend in stocks indicates an intent to keep selling among investors, with significant money gradually moving out of the stock. A selling trend is formed when prices create lower highs and lower lows.
- Sideways trend: Exhibited when subsequent highs equal previous highs and subsequent lows equal previous lows. The unclear trend direction of the stock indicates that major money or a crowd of investors are contesting with many conflicting intentions.
d. Consensus and Contrarian Trends
- Consensus trend: The agreement in price direction when comparing short and long time frames. The stronger the trend, the more it is agreed upon across both time frames.
- Contrarian trend: The reversal that occurs over short and long time frames. That is, when the trend in an extended timeframe is up or down, the opposite happens in a shorter timeframe.
2. Price Action Trading in Technical Analysis
a. What is price action?
Price action trading is based on a stock's price fluctuations. Investors observe price changes on technical charts to evaluate the trading behavior between buyers and sellers, and from there, they can determine the next price movements of that stock.
b. Strengths and weaknesses of price action:
Strengths:
- Easy to understand and apply: The price action trading method is exceptionally straightforward. Investors only need to observe the price movements on the chart to identify the following stock trends, thereby making investment decisions.
- No lag: Price action uses direct price charts, which are continuously updated, so investors can quickly access and anticipate price trends when making investment decisions.
- Enhances thinking ability: When trading based on price action, investors can independently assess and make investment decisions instead of relying on third-party data. This method allows investors to personalize their trading approach, enhancing their ability to observe and judge the market.
Weaknesses:
- High personalization: The price action trading method is more advantageous for experienced investors who have spent much time in the market. However, for less experienced investors, personal views on market assessment may lead them to risks when making subjectively dependent investment decisions.
- Price Action is not a successful trading method: As the market fluctuates daily, relying solely on this method for investment decisions can lead investors to make mistakes, such as when the stock market is manipulated.
- Time-consuming: This method requires more time to monitor and grasp market fluctuations. This can be challenging for many investors.
c. Analytical tools in price action:
Based on a single candlestick
Investors can extract much information from just one candlestick. Typical aspects such as open price, close price, highest price in the session, and lowest price in the session, the color of the candlestick or the wick, the length of the candle body, etc., are also quite essential factors in helping investors assess the supply and demand trends in the market.
Based on support and resistance
Through resistance and support zones, investors can find price ranges where stocks are likely to reverse direction or slow down before continuing their trend. When the price rises to resistance, it will reverse or stall, prompting investors to consider selling stocks. When the price drops to a support zone, it may reverse or stall, and investors might consider entering a buy order.
Candlestick patterns
Typical candlestick patterns provide investors with much information to quickly predict a stock's next trend. Some patterns may indicate a price reversal, helping investors make timely decisions and avoid losses. For example, Doji, Hammer, Shooting Star, etc.
Price patterns
When combining multiple candlesticks over a certain period, investors form price patterns. From these, investors can determine market sentiment and predict future price changes.
Examples include cup and handle, isolated island, double tops, double bottoms, head and shoulders, etc.