Top Technical Analysis Tools for Traders
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Technical analysis covers a broad spectrum of fields, from trend to momentum analysis, volume studies, and much more. Ultimately, a technical analyst, or ‘chartist’, has the job of assessing historical price and volume data to estimate future price movement.
What technical analysis tools to employ will depend on several aspects and is unique to each trader. Another point to be attentive to is that some traders combine fundamental analysis with technical analysis to navigate the markets. This means some just require the bare bones of technical tools to operate successfully, such as simple drawing tools; others who adopt technical analysis as the main vehicle of analysis will, of course, require more advanced applications.
Essential Drawing Tools
Technical analysis tools that permit traders to draw on charts are essential for all traders and are available on many trading platforms. These consist of applications like lines, channels, Fibonacci studies and shapes. Importantly, traders can use these tools across major financial instruments and on all timeframes, thus appealing to different trading styles.
By way of an example, the ability to plot support and resistance areas on a chart is imperative. In fact, it forms the backbone of many trading systems. As illustrated on the daily chart of the USD/JPY currency pair below, a support and resistance area has been applied using a rectangle. This simple approach allows the trader to extend horizontal support and resistance areas into the future to help determine where price action may react.
Another tool that is widely used among technical traders is ascending and descending lines to represent trendlines and channels. The idea behind trendlines, first and foremost, is their ability to help traders determine a trend, applied by pinning ascending and descending lines to a series of higher highs and higher lows (for uptrends) and lower lows and lower highs (for downtrends). Key points to note about trendlines are that they should not cut through price action and that they can, after two points of contact are achieved, offer support and resistance levels to work with. Below is an example of trendline support on the USD/JPY H1 chart.
Technical Indicators
In addition to drawing tools, traders often use technical indicators, which consist largely of leading and lagging gauges, to assist in analysing whether a market is overbought or oversold.
Popular indicators range from the Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) to determine momentum and trend identification, Bollinger Bands and the Average True Range (ATR) to assess volatility, volume to assess how much a security is being traded during a given period of time, and moving averages as well as the Average Directional Index (ADX) to identify trending markets (or possible trend reversals).
Moving Averages
Moving averages are widely used among technical analysts to filter price action and identify the underlying trend direction. Commonly used moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA), usually with values of 20, 50 and 200 periods. The SMA is equally weighted through previous closing prices, while the EMA applies more weight to recent data.
Below is an illustration of a 200-day Simple Moving Average applied to the daily chart of the USD/JPY. Notice how it filters out price fluctuations (highs and lows) and delivers a more precise read of the underlying trend direction using previous closing prices. However, it is vital to understand that this is a lagging indicator, meaning it is essentially confirming what has already occurred. This is why when a trend change happens, the Moving Averages will turn at a later point; hence, it is lagging.
Bollinger Bands
Another widely employed technical indicator is the Bollinger Bands, an indicator designed to assess volatility. Bollinger Bands are another lagging indicator, as the mean value is calculated using a 20-period Simple Moving Average with the outer bands set to two standard deviations of this value. Decreased volatility, therefore, is depicted through the tightening of the outer bands, thus converging with the central tendency. This is usually followed by an expansion in volatility, in which the outer bands widen, and can be a tradeable action for traders who employ this indicator. An example of Bollinger Bands is shown below on the daily chart of the USD/JPY.
Some traders also use the indicator to help locate support and resistance. When price tests the lower or upper bands, the security can revert to its mean. This is generally better traded alongside the current trend. For example, a market trending higher would likely have traders consider buy positions off the lower Bollinger Band and vice versa for a downtrend.
Trading with Superior Trading Tools
Each trader is unique, possessing different preferences for trading strategies and styles, as well as goals and risk tolerance. Consequently, one technical tool may be favoured by one trader, but it might be deemed ineffective by another. The objective of this article, therefore, is not only to highlight some of the more preferred key technical tools used by professional traders but also to encourage you to continue testing trading ideas to find the ideal combination of technical tools for your needs. This is the only way you’ll know what is right for you.
With FP Markets, you can begin back-testing and forward-testing your trading ideas across global markets using several popular trading platforms, including MetaTrader, cTrader, and TradingView. Consider opening a demo account today, or alternatively, check out the FP Markets Academy to learn more about the financial markets.
