Technical Analysis

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The Two Technical Analysis Approaches

Technical analysis uses different types of financial models and trading rules that are typically based on price movement or volume patterns. It involves analyzing varying price or return indicators such as moving averages, regressions, momentum analyzers, correlations, chart patterns, and many others. However, there are only two main approaches when it comes to technical analysis: a bottom-up approach and a top-down approach.

Bottom-up approach

This approach focuses on individual stocks first instead of the macroeconomic environment. First, the chartist picks out stocks that are fundamentally strong. They then use technical analysis to identify entry and exit points. The trader in this scenario often holds a long-term view of their trades.

Top-down approach

This approach first examines the macroeconomic factors that affect the industry/economy before zooming in to individual stocks. Traders following this approach often focus on short-term gains. Apart from these major approaches, traders also use different forms of technical analysis depending on what type of trader they are. For example, day traders often rely on volume indicators and trendlines to place orders. Swing traders focus on longer timeframes and prefer using other technical indicators and chart patterns to time their trades.

How to Trade Successfully with Technical Analysis

Most successful traders who rely on technical analysis shared that they have a strategy or trading system in place to give them an edge over the market. For example, a trader may find success trading a system in which he buys whenever price crosses over the 50-day moving average and sells when price fails to maintain its uptrend and crosses the moving average from above. Most real trading systems are more complicated than this simple example. However, the most important thing is to make sure you follow the system without deviation in real trading conditions.

Picking the Right Stock

Once you have a strategy in mind, it's time to scan the market for potential trade opportunities. The market presents new opportunities every day, it's the trader's job to spot them and fully take advantage of them. If your investing account size is not big, you may need to limit your choice to small-cap stocks. Others with more money to invest have more flexibility: They can choose any large-cap or mid-cap stocks that fit the criteria.

Backtesting Your Strategy

Your strategy may work well when applied to recent market conditions, however, there's no guarantee that it will work well 10 years ago or 10 years in the future. To maximize the chance of success, traders are advised to backtest their strategy against historical data. A vigorously backtested strategy through different timeframes has a higher chance of performing well in unknown future conditions.

Don't Get Emotionally Involved

Most traders fail to make money trading because they let their emotions take over when there's real money involved. Some have success trading a demo account but lose money when trading with real money because it's hard to think straight and follow the plan when a trade moves against you. Part of being a successful trader lies in the ability to control your emotions and not letting them dictate your trading. This can only be achieved with much practice and perseverance. Technical analysis is an important tool that sophisticated investors use to fine tune their trading decisions. Even if you base your trades on fundamental values, technical analysis helps you choose the right entry and exit points to maximize your profits and minimize potential downside. By mastering technical analysis and learning to control your emotions, you can improve your chance of successfully trading the market.

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