The four most dangerous words in investing are: ‘this time it’s different.’ – Sir John Templeton
In trading, there is no holy grail. There isn’t an absolute formula that one can follow that always leads to profitability. Every trading strategy has its weakness. Having said this, a good predictor of the future is the past but there is no guarantee that the past will repeat itself. Technical analysis attempts to use the past to predict the future.
What is Technical Analysis?
Steven B. Achellis in his book “Technical Analysis A to Z” defined Technical analysis, as “the process of analysing a security’s historical prices in an effort to determine probable future prices”. This is done by looking at charts and technical analysis indicators to determine future price movement.
Japanese candlestick chart patterns
Japanese Candlesticks have their origins from the trading principles of Munehisa Homma. Munehisa Homma was a Japanese trader who made his fortunes by trading rice in the 1700s. Munehisa was one of the first people to use past prices to forecast the price in the future. There are more than 50 Japanese candlestick patterns. For this post, I will only mention two patterns and show how they are used. For a further detailed description of candlestick patterns, you can read the book by Steve Nison, titled “Japanese candlesticks”.
Fig 1.1 is a reversal pattern meaning when it appears on a chart it will be signalling a change in the direction of the price. When the price is in a downtrend (the price is declining) Fig 1.1 is called a Hammer. When it appears in an uptrend (prices are rising) it is called a hanging man.
Technical Analysis Indicators
There are two popular types of indicators used. These are leading and lagging indicators. Leading indicators forecast what the price of the asset will do in the future such as the stochastic oscillator. In other words, leading indicators are used to determine when the direction of the current trend will change. A lagging indicator like the MACD (Moving Average Convergence and Divergence) shows the current direction of the price. To get a better understanding of technical analysis indicators you can read “Technical analysis A to Z” by Steven B. Achellis.