Many traders with a traditionalist mindset are skeptical when confronted with the question of whether or not technical price analysis can actually work when trading in the financial markets. But the reality is that technical analysis, or “price chart analysis,” is nothing more than the historical study of what market sentiment has changed in the past. This can involve looking at historical price activity in a number of different ways -- for example, using Moving Averages, Trading Ranges, or more complex patterns (like a head-and-shoulders or harmonic pattern).
Use in Constructing Trades
“Technical analysis techniques can be highly useful in constructing your specific trading ideas,” said Haris Constantinou, markets analyst at TeleTrade . “These formations are helpful because they can tell you how markets reacted at certain price points in the past.” Once the simpler methods are mastered, traders can look to more advanced techniques. These tend to rely on more complicated technical analysis strategies. For example, a technical chart formation like a double top or a candlestick pattern can be used as a way of marking suitable areas for a stop loss.
If we were to see a double top in the S&P 500 at 1500, we could take a short position and then place a stop 5 ticks above that formation, as it is unlikely prices will reach that level in the future. The same rules apply for buy positions, where areas of technical support (such as a trendline, Fibonacci level or candlestick formation) can be used to identify areas where stop losses should be placed. Expert traders tend to prefer this type of strategy because there is a better opportunity to structure a trade based on the changing dynamics of the market. But this highly specified approach takes a good deal of practice in order to perfect.
Remember to Always Manage Risk with Protective Stop Losses
Whichever technical analysis method you prefer to use, it is important to always remember that trades should not be taken without protective measures. For new traders, it can be difficult to focus on the potential downsides of trading (possible losses) but this is a reality that must be addressed in order to maintain a healthy account balance. Luckily, there is a variety of strategies that can be used to structure these trades, and these will differ depending on your individual trading style.
Because of this, it is important to focus not only on profit targets -- but on stop losses as well. These are the areas where a trader will close a position if the market moves in an unanticipated direction. Of course, this means accepting a loss. But the upside here is that stop losses can protect your account and keep your losses to a minimum. Stop losses are just as important (if not more important) than any other part of your trading strategy. Taking a loss is never easy, but using technical analysis techniques can help you understand just where your stops should be placed.
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