Image source: stockcharts.com
Technical Analysis is the art of identifying patterns in the market through pure chart patterns. Most short term traders use technical analysis in an attempt to identify market extremes and or to pick tops and bottoms.
Of course, position traders and investors, people that hold stock for many years collecting dividends and capital gains, can also trade purely off technical chart patterns. Instead of looking at the daily or weekly chart, these traders look at the monthly chart and identify major trends.
Most technicians use some sort of indicator. These indicators have been developed to try to identify profitable chart patterns. The problem is that everyone is looking at the same chart and using the same indicators. Furthermore, with the advancement of technology, HFTs (High-Frequency Trading) dominate the market. These computer algorithms provide most of the liquidity/volume for a given day’s stock price movement. Now that you know that the markets are dominated by computer algorithms and all the retail traders (individual traders like you and me) look at the same chart, how can we actually make money?
The way you compete with these algorithms is by trading on longer time frames. Most of these HFTs trade on shorter time frames intra-day. So as long as you are trading daily/weekly/monthly candles, you can come out ahead.
I’m a firm believer that most indicators show the same thing. Thus, I prefer reducing the clutter and just use moving averages. Moving averages help me gauge the strength of the upwards or downwards move. I will occasionally use the RSI (Relative Strength Index) to measure potential oversold or overbought conditions.
I will be updating my blog with RSI, Stochastics, and Bollinger Band strategies later.