Long term investors mostly depend on fundamental analysis such as growth rate, P/E ratio, revenue growth, net asset position, competitive position, dividend policy, corporate structure and other financial and non-financial information to determine the value of the company. As a principle, I prefer to invest stocks in which market price is below the net asset per-share value.
But short term traders such as day traders and swing traders mostly rely on technical analysis which focuses on historical market data including prices and volumes and uses chart patterns to predict future price movements.
Candlestick Charts for Technical Analysis
In the 18th century, Munehisa Homma a Japanese rice trader originated the candlestick charts. He developed this concept around the relationship among price, supply and demand, and the emotions of traders. In today’s context, traders use the candlesticks charts for technical analysis and make trading decisions based on frequently occurring patterns that help forecast the short-term direction of the price.
Understand the Candles
You should understand the candlestick to use it for your technical analysis. Candlesticks are mainly two types, bullish and bearish.
Body and wick are the main two components of a candle. These components indicate four things. (high price, low price, open price and close price).
Normally bearish candles are red and bullish candles are green. But trading platforms provide the facility of changing the color sometimes.
On a candlestick chart, the wick shows the day’s price range from the high to low. The wider part of the candle which is the body measures the distance between the open price and close price. If the open is higher than the close, it is a bearish candle. If the close is higher the open it is a bullish candle.
The open price shows the first price traded during the formation of the new candle. If the price starts to go upwards, the candle will turn green. If the price declines after the formation of the candle, It will turn red.
The high price describes the highest price traded during the formation of the candle.
The lower price indicates the lowest price traded during the formation of the candle.
Close price indicates the last traded price during the candlestick formation period.
Eg: If you look at 1 hour candle that starts at 10 am. The price at 11 am is the close price.
What Is a Trend
A trend is the direction of the market. But markets generally don’t move in a straight line in any direction. Market moves are characterized by a series of zigzags. These zigzags resemble a series of successive waves with reasonably apparent peaks and dips. It is the direction of those peaks and dips that constitutes the market trend.
An uptrend would be depicted as a series of successively higher peaks and dips, and a downtrend is just the opposite.
Supports and Resistance
In a trend, supports indicate level on the chart under the market where buying interest is sufficiently strong to overcome selling pressure. As a result, supports helps to stop the decline and turn back again. You can identify the support level using previous reaction lows.
Also, you can identify resistance by looking at previous peaks. Trading platforms provide you the facility to mark support and resistance levels in the charts using different tools.
How Support and Resistance Work
You should try to understand the rationale behind the support and resistance. I will divide all market participants into three main categories.
The longs, the shorts, and the uncommitted. The longs are the once who have already purchased, the shorts are the traders that have already committed themselves to the sell side. uncommitted are those who have either exited form the market or undecided as to which side to enter.
Imagine a situation where prices are fluctuating for some time and the market starts to move up from the support area.
How the longs will see this situation? The longs are now delighted but they are a bit worried about not having bought more and they wait for the market to dip back near that support area again so that they could add to their long positions.
Meanwhile, the shorts think they are on the wrong side of the market and they hope for a dip back to that area where they went short so they can get out of the market where they got in.
The uncommitted now start to realize prices are going up and decide to enter the market on the long side on the next dip.
Now all three groups are waiting for a good buying opportunity and on the next dip, all of them take a long position, and buying interest on the market goes up, and as a result, the price will be pushed up at the next dip.
Now let’s see what happens if prices move down instead of moving up. In the previous example, because prices move up, the combined reaction of the market participants caused each downside reaction to be met with additional buying. However, if prices start to drop and move below the support level, the reaction of the participants become just the opposite. All those who bought in the support area now realize that they have made a mistake and everyone starts to sell their position. As a result, support becomes resistance.