(Detailed) basic analysis of financial market
- 25 avgusta, 2022
- 11:11 dop
Analytical trading
There are two main types of trading: fundamental trading and trading using technical analysis. Fundamental trading is trading that focuses on the information available to justify the price in the market. It examines everything that can affect value from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors such as the effectiveness of company management.
The second type is trading using technical analysis, which focuses only on price. Technical analysis allows us to trade without emotions and thus use patterns from the past, as it assumes that history repeats itself.
A trader’s success depends on how well he can time his positions. When he enters or remains in positions that have positive expectations and exits when these positive expectations diminish. So, the central idea of trading is that we enter our positions according to probabilities, which means that the ability to trade depends on your ability to correctly assess these probabilities and act accordingly.
For every trader, it is extremely important what the current market conditions are, as this directly affects the portfolio of every investor. In the world of investing, we know two terms that describe current market conditions and potential; “bull” and “bear” markets. A “bull market” can have many “bear” cycles and vice versa.
On the picture: »Bull« and »Bear« trend
On the picture: »Bull« trend
During a bull market, prices are on the rise and economic conditions are generally favorable. Conversely, during a bear market, market sentiment is negative. Investors start moving their money into more stable income assets and wait for a positive movement in the stock market.
Since financial markets are heavily influenced by investor attitudes, these terms also indicate how investors currently feel about the market and the economic movements that follow. A useful tool for identifying bull and bear markets is to have a basic knowledge of stock price movements on a chart.
The most reliable and informative way of displaying price movements is the candlestick chart. Candles can be adjusted by choosing a time interval, from 1 second up to a month.
The candle is thickened between the opening and closing price in the selected time period, where the green color of the candle indicates that the closing price is higher than the opening. Otherwise, the candle is red. In addition, the thinner ends of the candle show us the lowest and highest value reached in our time period.
Candlesticks are one of the most popular components of technical analysis, allowing traders to quickly interpret price information from just a few candles.
Candlesticks are used to make trading decisions based on regularly occurring patterns that help predict short-term price direction.
On the picture: Price candle graph
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Support and resistance
Support & resistance (S/R), is a tool that most beginners in trading underestimate and do not pay enough attention to. Many successful traders rely solely on the S/R tool for trading or use it in combination with other indicators. In this method, the support indicates the price at which the buying pressure is greater than the selling pressure, so an area or a support line that acts as a basis for the price to move upwards. Specifically, demand is greater than supply at these levels, so an upward price movement is most likely. In order for the support to be clearly visible on the graph, it is best to increase our time frames, or to monitor price movements on a daily or weekly basis, where the movements are not so sudden (as seen on the picture).
In practice, of course, it is acceptable and technically correct if the support line crosses the candle or does not touch it at all, the goal of drawing support is to find a kind of zone and not an exact price, or a completely flat line.
On the other side, we have a resistance line, which indicates the price at which the selling pressure is higher than the buying pressure, which means that the supply is greater than the demand, thus pulling the price lower. In other words, here the probability that the price will rebound lower is very high.
On the picture: The letter S represents points of support
On the picture: Letter R represents the points of resistance
As with the support line, it is imperative that the resistance line is very easily visible and thus touches as many high points as possible on the price chart.
If price breaks the resistance line and then quickly returns below it. This is called a “false breakout“. A true breakout occurs when the resistance line is tested multiple times, leading to increased demand in that price range and thus we arrive at a breakout area.
Break-down is the same principle, where the support area is tested too many times, leading to an increase in supply at that price point and thus a reduction in price.
On the picture: »Break-Out« pattern
On the picture: »Break-Down« pattern
What happens if a support
or resistance line breaks?
The two lines begin to work oppositely; the support line becomes resistance and the resistance becomes support. This concept is extremely important to understand and confirm the trend in the market.
So, on the graph it is necessary to mark the extreme peaks and low points of the price fluctuation.
It is important that as the peaks rise, so does the bottom of the price fluctuation, which indicates a growing trend where we can expect a gradual rise in the price of the asset.
The opposite is also true for a downtrend, where a lack of demand will lead to lower and lower lows and lower highs that signal falling prices.
On the picture: Graph of a upward trend
Trend is your best friend
Past movements in the market allow us to analyze the movement of prices and with the help of this determine the trend. The main ingredient for identifying a trend is the highs and lows on the chart, i.e. the tops and bottoms of the candles. If we mark the extreme tops and bottoms and connect them with a line, we get a trend line. To correctly identify a trend, our trend line should touch at least three points on the chart, creating support or resistance.
So, to confirm an upward trend, we need to mark and connect the bottoms of the candles, and in the case of a downtrend, we connect the tops of the candles. When we manage to confirm the trend, it is crucial that the candles do not break through our newly drawn trend line. The purpose of trading with a trend line is to trade in the direction of the trend, so it is crucial to detect a change in direction in time and thus adjust your positions on the market immediately.
In the case of an upward trend, we start building our position in the market when the price approaches or touches the trend line and not when the price moves away from the line.
On the picture: Buying in the upward trend
Most people buy assets only during upward trends and thus misses the opportunity to make money during downward trends. Here, we can mention a very special financial tool that allows you to make money on the stock market even in caseof falling prices. This is “short selling”, which is a kind of bet on the stock market. Using this financial tool, you have the opportunity to speculate on the prices of raw materials, bonds, shares and currencies on the financial markets, which you do not necessarily own.
The whole purpose of using this tool is to take advantage of financial crises or scandals where stock prices suffer the most. Of course, this strategy is very dangerous for the loss of the entire property, but many have managed to predict falls in the stock markets and thus used them to increase earnings.
Larger companies and investors in gold usually use this tool to protect themselves from a fall in value by opening a “short sell” position on the stock exchange, where they sell gold with the intention of buying it back when the price falls. Using a “Long position” thus allows us to increase our exposure to the market and take advantage of the strength of the rising trend. For example, if you have $1,000 of capital, you can use long leverage to buy $2,000 or more worth of Bitcoin. In this case, both profit and loss are multiplied by leverage. 10% rise/fall in price in case of long position with 2x leverage will lead to 20% profit/loss.
However, when using Long/Short positions or resistance lines in trend trading, there are dangers such as a false breakout, which is mostly used by larger institutions to stop the positions of smaller traders. With huge sums of capital, they can cause major price movements and thus push out or they mislead other traders who do not expect a trend breakout.
In a false breakout, the price temporarily moves above or below a key level of support or resistance, and then later pulls back to the same side where it started. This is the worst case scenario for a breakout trader who enters a position as soon as the price breaks.
How to secure your earnings?
When planning the strategy of any trader, it is important to minimize the risk of
losing profits as much as possible. This means that it is everyone’s responsibility to calculate the level of risk that is acceptable to them compared to the level of sufficient profit.
Based on the calculation, you can then more easily determine how much money you are willing to lose before exiting the position and thus recording a loss. Any trader will see multiple losses per day, which is part of a successful strategy. The trader’s goal is to have more successful transactions than unsuccessful ones at the end of the day, month or year. The main purpose of a “stop-loss” order is therefore to reduce exposure to risk (by limiting possible losses) and to facilitate trading with a pre-established order that will be automatically executed if the asset trades at a certain price on the market. Of course, in the case of a “stop loss” order there are also risks involved.
On the picture: Example of a stop-loss order
A trader that buys shares at $100 per share can enter a stop-loss order to sell his shares at $95 per share, risking only 5% of his position. There is a risk that the share price will bounce back at $95 and start an upward trend where we will miss out on a potential profit due to a stop-loss order. Therefore, it is extremely important here to know the technical tools that allow us to correctly position our orders and regularly edit our orders before losing profit.
The use of such orders is crucial in leveraged trading (short and long orders), where you borrow your investment funds from the stock market and thus avoid losing your position completely.
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The most popular indicators in trading
The indicator that traders usually use to start the technical analysis process is the moving average (MA). It is often one of the first indicators that traders will add to their charts and serves as a standalone indicator or for comparison with other indicators.
A moving average (MA) is a simple tool that simplifies asset price data by creating a constantly updated average price. Traders use it to visualize where the price has been and in which direction it might move in the future. As a result, it is mostly used to show the trend.
The average is calculated based on a selected time period, such as 20 minutes, 10 days, 30 weeks, or any time period we choose. The most popular indicators for technical analysis are usually the 50 daily moving average (50MA) and the 200 daily moving average (200MA). The 200 daily moving average is calculated by adding the closing prices of the last 200 days and dividing by 200.
Using the tool, we can filter noise or sudden price movements, as short-term price movements will not have much effect on the price average in the longer term.
In the vast majority of cases, when the short-term moving average crosses above the long-term one, it indicates a bullish trend. Conversely, when the long-term moving average falls below the short-term one, it is seen as a bearish trend. Many short and long term traders use this indicator to enter and exit positions.
The moving average has proven to be a very reliable indicator of many severe bear markets over the past century. A death cross usually occurs when the 50-day moving average falls below the 200-day moving average. A death cross is a chart pattern that usually indicates the possibility of a large selloff in stocks.
It is important for both opportunistic traders and day traders to be aware of the “death cross” event when it occurs, as it allows them to stay ahead of the crowd and prepare for an upcoming buying opportunity.
On the other hand, we have a golden cross, which indicates the possibility of a potential bullish trend.
On the picture: »Death Cross«
On the picture: »Golden Cross«
The moving average is most often used in combination with the relative strength indicator or RSI (“Relative Strength Index”), which defines when stocks are overbought or oversold. It is used as a momentum indicator and thus gives signals to enter and exit a position. By varying the value between 0 and 100, it measures the current momentum of the stock, where a value above 50 signals an upward trend and below 50 signals a downward trend. To understand the RSI, it is typical that when the value moves above 70, the stock is overbought and a drop in price should follow, and when it falls below 30, the stock should be oversold, followed by an increase.
The indicator works by focusing on the location of the asset’s closing price relative to the price range over a specified number of historical periods. Usually 14 previous periods are used to calculate the RSI. By comparing the closing price with previous price movements, the indicator tries to predict turning points and thus forecast the trend.
So, if 14 periods are used to calculate the relative strength indicator, it means that the last 14 price candles are analyzed, or time intervals.
The objective of the indicator is to analyze the closing price of each candle for the last 14 candles, as well as the size of the candle and determine whether they are bullish (green) or bearish (red) on average.
On the picture: »RSI« or Relative Strenght Indicator
If all 14 candles are bullish, then the relative strength indicator is 100. For the indicator to read 50, you would need 7 bullish and 7 bearish candles. In this case, the indicator tells us that the average profit and loss are equal.
In reality, in an upward trend or a bull market, the RSI sticks to the range from 40 to 90, where the range from 40 to 50 acts as support. However, during a downward trend or bear market, the RSI tends to stay between the range of 10 to 60, with the 50 to 60 range acting as resistance. These ranges may vary depending on the RSI settings and the strength of the traded asset.
If we upgrade the RSI indicator with another line on the chart, we get the Stochastic Oscillator, which is used to measure the strength and weakness of the Relative Strength Indicator (RSI) over a certain period of time.
Both indicators are used to measure price momentum, while the Stochastic Oscillator is based on the assumption that closing prices should close close to the same direction as the current trend, while the RSI tracks overbought and oversold zones by measuring the speed of price movement.
In general, RSI is more useful during downward trends and upward trends, while Stochastic provides more reliable information during side trends or in a volatile market.
On the stock exchanges, there is no better indicator of market activity than the volume of turnover. Volume indicates the level of activity in the market. The assumption that trading volume jumps ahead of prices is the basis for volume analysis.
Usually, trading volume refers to the number of transactions made per day. Understanding the volume of the overall market versus the volume of an individual economy can be one important comparison that helps analysts discern volume trends. In an upward trend, trading should increase in line with rising prices and decrease in the case of falling prices.
On the picture: BTC price rise with increased trading volume
An increase in trading volume indicates an increase in interest and buying/selling by large institutions, in other words the entry of “smart money”. Larger institutions are generally considered to have access to better analysis and more information, so certain areas on the graph where the trading rate is extremely high reflect high institutional interest.
Areas with lower trading volume, on the other hand, are typical of smaller investors with much smaller amounts of capital and information, which is typical for periods of uncertainty.
In general, it is important for technical analysis to include range indicators in daily chart diagrams. Range charts are usually seen below a standard candlestick chart, where the right side shows the trading volume for each time period. Incorporating trading volume into a trading decision can help an investor have a more balanced view of all the broader market factors that could affect the price of a traded asset, helping the investor make more informed decisions.
Traders rely on volume as a key metric because it allows them to see the level of liquidity of an asset. By determining the relationship between trading volume and price at a certain level on the chart, it is possible to see how difficult it will be to exit the position or enter depending on the level of liquidity offered.
Days with higher than usual volume of traffic usually lead to large swings in price.
The image below is an example of trading a 4-hour chart, where each volume bar visible at the bottom of the chart shows how many shares were traded in each 4-hour period. The trading volume lines on the daily chart therefore show how many shares change hands each day.
From the chart below, we can see that the jump in trading volume led to an increase in price in the following days, as well as increased interest in the traded asset on the stock exchange.
Slika prikezuje: Skok v količini trgovanja je vodil k zvišanju cene v naslednjih dneh.
Many traders join the trade only in case of high liquidity, which is mostly an expression of high volume. So the bigger the volume, the easier it is for you to buy and sell large or small amounts of stock because there are other traders in the market waiting to fill the other side of your transaction. As a result, many crypto day traders choose to trade on the Binance exchange, as many tokens have enough liquidity that they can easily exit the position whenever they want.
In addition to knowledge and experience, the most important qualities for a trader are discipline and mental fortitude. Discipline is required to stick to your trading strategy in the face of daily challenges. Without discipline, small losses can turn into big ones. But it also takes mental fortitude to recover from the inevitable dips and bad trading days that will occur in any trader’s career. Becoming a successful investor does not mean that we have to find a stock that will at the top of the market in the next few days and that will make us rich. Really great investments allow us to grow organically over the long term, which is an argument for treating active investing as a hobby rather than a get-rich-quick tool.
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