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Discover the power of technical analysis for informed trading
Ever thought about using Python coding skills to navigate the trading world, but not sure where to start? The answer might just lie in the captivating world of technical analysis! In this session, we'll explore the concept of technical analysis which is widely used by both manual and algorithmic traders.
Our exploration will cover the basics of technical analysis, its application in trading, and a specialised approach known as Price Action Trading. Additionally, we will discuss the pivotal concepts of support and resistance levels and unveil a practical trading strategy based on these levels.
What is Technical Analysis?
Technical analysis is a method used in trading and investing to evaluate and forecast the price movements of financial instruments, such as stocks, currencies, commodities, and indices.
It primarily relies on the analysis of historical price data, trading volume, and other market statistics to identify patterns and trends that present an understanding of the current market conditions and may indicate potential future price movements.
How is Technical Analysis Used in Trading?
In trading, technical analysis involves using historical price data to identify trends, support/resistance levels, and chart patterns.
Traders employ indicators like moving averages and RSI for signals of potential price changes. The goal is to make informed decisions about buying or selling financial instruments, acknowledging that no analysis guarantees success and that risk management is crucial.
There are many ways to use technical analysis for trading, out of which ‘price action trading’ is one of the most used approaches.
You can learn more in the learning track with courses on technical analysis.
What is Price Action Trading?
Price action trading is a form of technical analysis that focuses primarily on the movement of price itself, rather than relying on indicators or other external factors.
One of the main principles of price action trading is the belief that all relevant information is already reflected in the price. Therefore, instead of relying on external indicators, traders focus on understanding and interpreting the price movements themselves.
Finding support and resistance levels of an asset is one of the crucial steps of price action trading.
What are Support and Resistance Levels?
Support and resistance levels are key concepts in technical analysis that help traders identify potential price levels at which a financial instrument may experience a halt or reversal in its trend. These levels are determined by historical price movements and are used to make informed trading decisions.
Support Level:
A support level is a price level at which a financial instrument has historically had difficulty falling below. It's a level where buying interest tends to be strong enough to prevent the price from declining further.
To manually identify a support level, traders analyze historical price data, looking for points where the price rebounded or halted its decline at least twice.
Resistance Level:
A resistance level is a price level at which a financial instrument has historically had difficulty rising above. It's a level where selling interest tends to be strong enough to prevent the price from moving higher.
To manually identify a resistance level, traders examine historical price data, pinpointing instances where the price reversed or faced a barrier at least twice.
It is important to emphasise that, while the ideal scenario involves the price reversing or rebounding at least twice from the same price point to establish a support or resistance level, these two price points need not be precisely identical; rather, they should be in close proximity.
In such instances, one may consider either the average of these two points as a support or resistance level or define a price zone with these two points serving as the boundaries of the zone.
Trading Strategy Based on Support and Resistance Levels
- If a level serves as a support level, it indicates that the price has previously rebounded from that level. Consequently, there exists the potential for the price to rebound again when retesting that level.
- Similarly, when a level acts as a resistance level, it signifies that the price has retreated from that level at least once. Therefore, there is a likelihood that upon retesting that level, the price may decline once more.
In situations where the price of an asset lacks a strong trend in a singular direction,
- A long position can be initiated when the price reaches the support level,
- A short position can be established when the price reaches the resistance level.
For instances when the market exhibits a robust trend in a specific direction, such as an upward trend, a strategy involves waiting for the price to retrace to the nearest support level. Subsequently, taking a long position becomes an opportunity to engage in the overall trend.
As an illustrative example, consider a strategy focused on support levels.
The implementation involves the following steps:
Step 1: Identify the support levels within the closest historical data of the asset prices.
Step 2: Initiate a long position when the price reaches the support level, i.e., the asset trades at or below the support levels in the data following the historical period.
Step 3: Monitor the open long position and exit either when the price reaches the nearest resistance or when it reaches a predefined profit percentage, such as 5% or 10%.
You can easily automate the process of identifying the support levels and trading based on them using Python. Not only that, you can also backtest the price action trading strategy based on the support level using Python.
You can check this section Strategy Using Support and Resistance to download the Python notebooks for support, resistance levels identification and backtest price action trading strategy based on the support levels. This section of the course also explains how to draw support and resistance manually and define trading rules for the strategy based on support and resistance.
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IMPORTANT DISCLAIMER: This email is for educational purposes only and is not a solicitation or recommendation to buy or sell any securities. Investing in financial markets involves risks and you should seek the advice of a licensed financial advisor before making any investment decisions. Your investment decisions are solely your responsibility. The information provided is based on publicly available data and our own analysis, and we do not guarantee its accuracy or completeness. By no means is this communication sent as the licensed equity analysts or financial advisors and it should not be construed as professional advice or a recommendation to buy or sell any securities or any other kind of asset.
