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TECHNICAL ANALYSIS


The Very Basics Of Technical Analysis

02/08/12 09:09:28 AM
by Alan R. Northam

A mini-refresher course on the very basics of technical analysis.

Security:   .DJI
Position:   N/A

Sometimes traders get caught up in the moment of analyzing a security or a market index, identifying buy & sell triggers, and determining stops and profit targets and just forget about the basics. I often reread my books on technical analysis, and every time I find something I missed during the previous reading or something I overlooked. Sometimes we just need to step back and revisit the very basics of technical analysis and how they can affect our trading for the better.

Figure 1 is a price chart of the Dow Jones Industrial Average (DJIA). This chart shows the daily closing prices of the DJIA as black round dots. I have interconnected these dots with dashed lines to make it a little easier in recognizing the progression of the dots. The chart shows the rally that started in October 2011 and ended later that month. The purpose of our analysis is to determine when the trend started, how many rallies were involved, and when the trend ended.

FIGURE 1: DAILY PRICE CHART, .DJI. This chart shows the daily closing prices of the DJIA during October and November 2011. The numbers above each closing price represents the length of time for each rally within the uptrend.
Graphic provided by: MetaStock.
 
The most important price of each trading day is the closing price, and the very basics of technical analysis is involved in the interpretation of these closing prices. In Figure 1, I have identified the closing prices with numbers above the round black dot that represents each day's closing price. The first dot, or closing price, that is higher than the previous closing price is marked with "1." This dot represents the beginning of a new rally. The dot with "2" above it represents the second daily closing price that is higher than the previous closing price and so on. Note that the first rally from the beginning of October 2011 only lasted three trading sessions before a closing price closed lower than the previous closing price. When a closing price closes lower than the previous closing price, that closing price marked the end of the previous rally. Note also that there were three rallies during October that lasted for three trading sessions. It is important to know how long each of these rallies last as they are a clue to their individual strengths.

Next, I want to look at the rallies around the middle of October. Note the red "1" above each of the daily closing prices. These red numbers represent failed rallies. Failed rallies are one-session rallies that are interrupted by a following lower daily close. Failed rallies normally occur around areas of overhead resistance in the case of upward rallies and around areas of support in the case of downward rallies. If we zoomed out on our daily price chart, we would see that these one-session wonders did in fact occur around an area of overhead resistance. The thing to remember about failed rallies is that they identify areas of overhead resistance to upward rallies and support to downward rallies.

Next, I want to examine the daily closing prices during the first half of November 2011. Note that during this time, there were three separate rallies that lasted two days instead of three. This is important, as it identified a weakening of the uptrend, as each rally only had the strength to last for two trading sessions. Note also that neither of these three rallies were able to make a new high. This is evidence that the current uptrend could very well be coming to an end. From the middle of November onward, note that the closing prices started making a series of successive lower closing prices, indicating that the trend had reversed from upward to downward.

Analyzing each daily closing price can identify the beginning of a new trend. Identifying how many rallies are involved in each trend helps to identify its strength as compared to previous trends. By analyzing the movement of each closing price, we can also identify the strength of each rally and whether the trend is gaining strength or losing strength. The movement of each closing price can also identify areas of overhead resistance or areas of support. And finally, by analyzing each closing price, it is possible to tell when one trend ends and a new opposite one begins. And I should also mention that this same very basic method of technical analysis can be applied to any time frame.




Alan R. Northam

Alan Northam lives in the Dallas, Texas area and as an electronic engineer gave him an analytical mind from which he has developed a thorough knowledge of stock market technical analysis. His abilities to analyze the future direction of the stock market has allowed him to successfully trade of his own portfolio over the last 30 years. Mr. Northam is now retired and trading the stock market full time. You can reach him at inquiry@tradersclassroom.com or by visiting his website at http://www.tradersclassroom.com. You can also follow him on Twitter @TradersClassrm.

Garland, Tx
Website: www.tradersclassroom.com
E-mail address: inquiry@tradersclassroom.com

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