10 Different Views of Technical Analysis

This is going to be a lengthy post that attempts to cover a good portion of what I've learned so far in Technical Analysis after doing it for nearly 2 years and how I see it being used in the industry. Technical Analysis is constantly evolving and it is quite evident that there are tons of different methods available to use.

We all have our own preferences and everyone of us have our own way of practicing Technical Analysis. The reason why everyone doesn't use the same indicators is because not one system works on its own.  I believe people unsuccessfully continue to search for the indicator which will give clear buy and sell signals. Not one indicator works 100% of the time, but if you use every tool available to you, I believe Technical Analysis can help increase the odds in your favor.

If there was one indicator that worked then we'd all probably be millionaires by now, or I wouldn't be posting about it on the Internet telling you about it. As people become more aware of Technical Indicators I believe they become less reliable. On the other hand, I believe if enough people look at the same indicator that it will become a self fulfilling prophecy and serve some type of importance. For example, the 20 day simple moving average. I believe this has to be the most widely watched indicator. I guess this is supposed to represent a moving average of 1 months trading. You often hear how prices will "bounce off the 20dma." Why do you think this is? Is 20 some magical number? I believe it has become a psychological level that if prices approach the 20dma that you need to take action. A lot of Technical Analysis is about market psychology, something even I'm still learning myself.

What I'm about to cover are the different 'levels' of Technical Analysis. Please ignore the names that I've given, but just understand the fact that I believe the sophistication of the analysis becomes greater as you continue to read. A lot of this post is going to be able my personal evolution as a Technical Analyst.

1) The Rookie Technician

Tools:

• Volume Histogram
• OHLC bars
• Price overlay: 20,50,200 Simple Moving Averages

This previous discussion leads me into the most basic form of Technical Analysis. I believe anyone who at least attempts Technical Analysis employs these strategies and watches these indicators. This person watches volume to see if its heavy/light and follows trends by looking at the moving averages. They may use the moving averages as support/resistance but more likely would rather look for crosses in the moving averages. I believe we all started here at one point.

2) Basic Support/Resistance Technician

Tools:

• Candlesticks
• Horizontal Price Levels
• Volume Histogram or Volume by Price (not shown)

Using horizontal levels to define support and resistance is very common place. It was very common to hear last year on the media as we continued to go lower that the DJIA was about to test key support at such and such price. They simply pulled up a longer term chart and tried to find extreme lows as I did above. Obviously prices don't come exactly to these price levels all the time, and other times they go further then these price levels. A key to drawing these levels are to try to connect as many closes/opens/lows/highs as you can. This is much easier to construct using a candlestick chart. Using volume is also helpful to identify your pivot points (extreme highs/extreme lows). For example if you see a day with an exceptional amount of volume, it was obviously an important day and prices attracted enough people to take action. You can expect these same price levels will attract investors as they approach again.

3) The Basic Technician

Tools:

• Colored Volume Histogram
• Candlesticks
• Price overlay: 20, 50 Exponential Moving Averages
• Price overlay: 200 Simple Moving Average
• Favorite Oscillators: Typically 2 or 3 of the following: RSI (14), MACD (12, 26, 9), Stochastics, ADX/DI, etc.

The Basic Technician takes it a step further and now incorporates a group of basic indicators to assist in his/her trading. Initially they will go by the book and attempt to trade the oscillators as they were originally designed. For example, buy below 30 RSI and sell above 70%. Obviously they come to learn this doesn't always work and they soon come very familiar with other strategies such as divergences and making custom adjustments to the indicators. In addition they gain a basic understanding of candlesticks and employ a faster set of moving averages by using the 20 and 50 Exponential Moving Averages.

4) Trendline Technician

Tools:

• Trendlines
• Channels
• Volume Histogram

By now I've described what I would guess would be about 40-50% of the technicians out there. I believe most people who do basic technical analysis won't go any farther then what I've described so far and are content with just drawing price levels to try to identify areas of support/resistance. However if you are going to be a successful trader it might be useful to incorporate trendlines into your analysis. As I described above,  prices rarely go down to a specific price before deciding its time to reverse. However prices do tend to stay within their trendlines fairly often. The key is drawing the trendlines properly. Using volume combined with price action is very helpful in doing so. Channels are very useful and are used by the most experienced technicians, including those who practice Elliott Wave, to identify both key support and resistance levels at the same time.

5) Pattern Technician

Tools:

• Trendlines
• Knowledge of all patterns
• Volume Histogram
• Oscillators (not shown)

By definition every technician tries to look for patterns in order to forecast future price movement and I'm sure everyone has visited Investopedia's Chart University at least once. However there is a certain degree of sophistication required to identify true patterns. It takes time to develop the knowledge of patterns, their targets, and signals of a true breakout. Experienced technicians in this area can glance at a chart and immediately point out patterns without giving much thought at all. However as I've said before the more people that know about a specific pattern the more likely it is to fail. I've seen so many head and shoulder's patterns fail recently, so it is important to use other indicators such as oscillators and volume to confirm the price pattern. Also these technicians come up with their own breakout qualifiers and wait for confirmation before taking action.

6) Fibonnaci Forecaster

Tools:

• A Platform which has all tools available
• Fibonnaci Arcs, Time Ratios, Retracements, Retracements, Extensions, Fans
• A knowledge of the Fibonnaci Ratios and Sequence

I believe Fibonnaci is the most important aspect of Technical Analysis and is probably the most helpful in forecasting the markets. The degree of sophistication here is determined in which tools you use and how much time you put into your analysis. A simple retracement is done by everybody, but there are so many other tools available that all base themselves on the Fibonacci ratios that not too many people use. For example I don't read up too much on people using Fibonnaci Arcs but I believe they can still a useful tool. The key is finding the right points to connect to and seeing how the tool has worked in the past. If it played a significant role in the past, probabilities are you can count on it working in the future. For example if you would have drawn the Fibonnaci Arc above and saw that it acted as resistance in March 08 and October 08 you could have kept a close eye on it and done a pretty good job predicting the low in March 09. I came across this Arc yesterday, and it will be important to continue watching it going forward.

7) Elliott Wave 

Tools:

• Good knowledge of all aspects of Technical Analysis
• Knowledge of the Wave Patterns and the 3 Rules of Elliott Wave
• Fibonnaci Tools and Time Ratios
• Channels
• Oscillators
• Volume
• Divergences

Now that we've moved fairly far down the list we've moved into Elliott Wave which is on the top of my list for  difficulty and sophistication required to perform the analysis. There are only a few good analysts out there who have valid counts but many people pay for this information. I know instititions do follow Elliott Wave despite how subjective it is, because it is evident even in the chart above that it works. Elliott Wave attempts to explain that the market moves in waves bounded by Fibonnaci. For example notice above how corrective wave 4 is 61.8% of the size of corrective wave 2. Also Wave 3 is 123.6% of Wave 1. Although not annotated in the chart above, price projections can be performed in a similar matter.

8) Cycle Forecaster

Tools:

• Cycle tools
• Time Ratios
• Knowledge of Calendar Cycles and Dates

There seems to be tons of indicators available on price since price is what drives your return on an investment. However cycles and precise timing seem to be overlooked and very difficult to find information on. Even I cannot comment too much on this since I have yet to study much on the use of cycles. However there are plenty of services out there that claim they know the dates in which the market will see a turn or begin reversing. Its up to you whether you believe them.

9) Demark Technician

Tools:

• A valid charting platform
• Demark Indicators

I recently came across these indicators and there doesn't seem to be much information on the web about them. However I believe enough research has went into the indicators and they work impressively enough to be put in their own category. Developed by Tom Demark, the most popular and probably the most useful is his Sequential timing indicator. Although there has been development through other platforms, I believe the Bloomberg Terminal has the most correct versions. Unfortunately your average investor cannot afford such an expensive tool but you can be sure all the institutions keep an eye on Sequential.

10) Custom Indicators

Tools:

• A creative mind
• Programming ability
• A platform that allows for custom indicators

Everyone out there wants to make money. Some of us are not content with what has been provided and try to  develop our own indicators. Shown above is a version of Guppy MA of which I found somewhere on the web and I apologize ahead of time for not giving credit to who developed it. I believe it does a great job of pointing out the current short term and long term trends. Also I've overlayed a simple Bollinger Band which is another indicator that many people use. Using all indicators in unison can generate positive results.

I've gone through a list of 10 different ways of looking at Technical Analysis, but the truth is there are unlimited ways to analyze the market. Somewhere in between all the discussion above is the analysis of market internals, sentiment, volatility, and so many others. There are also plenty of other indicators and tools that I do not mention because I do not have much familiarity with them. Probably the biggest are the Gann tools and the use of other tools such as Andrew's Pitchfork. Perhaps sometime down the line I can include them in this post after I've had some experience with them.