Types of Stock Market Analysis

In fact the type of analysis means some way of judgment and assessment of market situation to make a decision about its perspectives. There are three well-known types of analysis:

1. Fundamental analysis
2. Technical analysis
3. Sentiment analysis

Which Type of Analysis is Best?

Throughout your journey as an aspiring  trader you will find strong advocates for each type of analysis. Do not be fooled by these one-sided extremists! One is not better than the other…they are all just different ways to look at the market.

At the end of the day, you should trade based on the type of analysis you are most comfortable and profitable with.

To recap, technical analysis is the study of price movement on the charts while fundamental analysis takes a look at how the country’s economy is doing.

Market sentiment analysis determines whether the market is bullish or bearish on the current or future fundamental outlook.

Fundamental factors shape sentiment, while technical analysis helps us visualize that sentiment and apply a framework for our trades.

Those three work hand-in-hand-in-hand to help you come up with good trade ideas. All the historical price action and economic figures are there – all you have to do is put on your thinking cap and put those analytical skills to the test!

Let me pull out that three-legged stool again just to emphasize the importance of all three types of analysis.

Take out one or two legs of the stool and it’s going to be shaky!

In order to become a true trader you will need to know how to effectively use these three types of analysis.
Don’t believe us?
Let us give you an example of how focusing on only one type of analysis can turn into a disaster.

• Let’s say that you’re looking at your charts and you find a good trading opportunity. You get all excited thinking about the money that’s going to be raining down from the sky.
  You say to yourself, “Man, I’ve never seen a more perfect trading opportunity in GBP/USD. I love my charts. Now show me the money!”
• You then proceed to buy GBP/USD with a big fat smile on your face (the kind where all your teeth are showing).
• But wait! All of a sudden the trade makes a 100 pip move in the OTHER DIRECTION! Little did you know, one of the major banks in London filed for bankruptcy! Suddenly, everyone’s sentiment towards Britain’s market turns sour and everyone trades in the opposite direction!
• Your big fat smile turns into mush and you start getting angry at your charts. You throw your computer on the ground and begin to pulverize it. You just lost a bunch of money, and now your computer is broken into a billion pieces. And it’s all because you completely ignored fundamental analysis and sentimental analysis.

What type of analysis is better ? Whit a different view -

Right,  first  give you very simple answer, but then explain more. And the answer is as follows – do we really need some other types of analysis, if we have some best of the best? For example, if technical analysis is the best type, why do we still talk about the others?
First, on your trader’s way, you will meet absolutely different, occasionally fantastic traders, who will try to prove to you, that some way of analysis (likely that they use themselves) is a best. You will meet fans as technical analysis as fundamental, may be even other types of analysis that we do not even know (moon cycles). Don’t be confused by these one-sided enthusiasts. As I already have alluded, no one type of analysis is better than the other. They are just a possibility to look at the market from three different points, and you will get 3D-picture, instead of 2-D, or even 1-D (If it’s possible at all!). Although we’ve already discussed, that as a rule, most traders pick some type of analysis as their primary one, because it gives best results or is most suitable for their particular way of trading and secondary types, that trader uses to interpret current situation on the market. See, we need all types together, and here is how it works:

Fundamental analysis

It’s unwise to negate the fact that eventually currency rates move due county economic health per se relative to other economies. So, if one economy is healthy and has even stronger perspective and potential, then its currency gains, if not – its currency loses. That is what fundamental analysis stands for. It helps us to make a conclusion about if an economy is healthy at all or not, what perspective does it have, does it grow, flat or recess, is it stronger than another economy, say, EU or not, etc. As a result of the application of fundamental analysis, each trader forms his/her own fundamental outlook as on the current situation as on the future. Let’s go further…

Sentimental analysis

We come to the conclusion that each trader has own fundamental outlook on some country’s economy, say, the US of A. But what does it mean? It means is that each trader has a view how bearish or bullish he/she is on particular economy. The total of these opinions creates a market sentiment. So, fundamental analysis creates shape of assessment by market participants of a US economy, i.e. – total market view (i.e. sentiment) on economy and bullish or bearish sentiment itself.

Technical analysis

As technical analysis is dealing with charts – it allows us to see this current market sentiment both in real-time and as historical and to analyze it with technical tools. In fact, you have all that you need – historical prices, all the necessary figures and data. All you need now is to just study how to apply in-depth analysis as best as you can do and make good trades. You’ve seen what a financial catastrophe will be upon you, if you will rely on just technical analysis and totally ignore fundamental and sentiment.

The role of sentiment analysis

Here is another example. Assume that your fundamental analysis shows that economy is growing and on the way to recovery. This assumes that unemployment rate should gradually decrease. Let’s further assume that today is unemployment data release for recent month and you expect unemployment decreasing. You switch on the CNBC channel and a lot of big-headed guys talk about unemployment rate and how important to see it’s decreasing to support the pace of recovery, blah-blah-blah – anyway you’ve got the point - other market participants expect the same, and you just switch the TV off. When the data has been released and unemployment really shows a decrease, you expect to see appreciation of the USD rate and open a trade based on this. Instead of what you expected, you see a strong move against your position. Why, what has happened? Unemployment decreased, the economy grows, what’s wrong, why is everybody selling USD currently? The point is that you totally ignored the sentiment of the market, how bullish or bearish their view on economy. If you have watched CNBC a bit longer that you see that market expectations was for an unemployment reduction of 0.25%, but data that has been released shows a reduction just for 0.1%. It means that the current pace of growth is slower that was expected initially and the USD is overvalued. That’s why it leads to a sell-off of USD on the market. On that simple example you can see, how important Sentiment analysis is.

Combination of different types of analysis

Here I want to show you how you can combine all types. For instance you are the trader who trades long-term trends, and fundamental analysis is a particular important one for you. You do a good job and estimate possible long-term trends changing due to changing situation in fundamentals factors of the US economy, you take into account a public sentiment as well, to fairly judge effect of new released macro data.

Say, currently, you see that the economy turns to recovery and shows signs of strength, you see better and better macro data, crowd appetite for positive data (i.e. sentiment) is growing also and you decide to enter on the market based on this – Sell EUR/USD, for instance. But now the question – where to enter, where to place stop/loss order? How can this be done with fundamental analysis? Of cause, you have a possibility just to enter at market without any stops , but in this case you indeed must have ruby wallet to hold any move against you, and this move could be really solid – remember, you trade long-term.
Here is where we come to technical analysis. You can analyze charts and find the area to enter – for example strong resistance level on monthly chart and to place a stop order. Should not rely just on one of them. But here you can see another major task – you have to learn to balance them optimally to get best results. In the nearest time we will dedicate lessons to deeper investigation of technical analysis. First, we will take a look at different chart types, and learn how to read them. Then, we will turn to the classical approach to technical analysis – classical patterns, trend lines, support , resistance and a lot of different indicators. After that we will turn to advanced and more sophisticated part of technical analysis – Fibonacci tools, Elliot wave theory, Gartley’s patterns, pivot points and other stuff.
And only after that will shift to fundamental and sentimental analysis.

What is Technical Analysis : 

Technical analysis is a method to analyze the future possible direction of price movement of currency pairs or securities or other financial assets by using past market data, primary price and volume. Technical analysts use charts, indicators and other drawing tools to understand the future possible price movements and its direction. Technical analysis has become very popular for short term, midterm and long term trading. Like other financial markets, technical analysis is widely used in Stock, Commodities and forex markets. Technical analysts develop trading rules and trading systems by using various indicators, theories and charting tools to analyze the Stock, Commodities and forex markets. Technical analysts focus on price actions rather than the fundamental condition of the currency pair. However, technical analysis can be combined with fundamental analysis to obtain a better result.

Basic Assumptions of Technical Analysis:

There are some basic assumptions of technical analysis. These are,

Price discounts everything:

Technical analysts believe that all the relevant information is already reflected in the price. This is why technical analysts tend to understand mass traders’ sentiment on this relevant information which has already reflected in the price of that asset or currency.

Price moves in trends:

Technical analysts believe that price moves in trend. A trend can be uptrend, downtrend or flat. An uptrend means an upward direction of price in a long timeframe. Inversely, a downtrend reflects a long term downward movement of price. Trend is considered as flat or ranging when the market is stuck in range and not moving in any specific direction. In this case,  it is considered that there is no trend. Here is an example chart of trends (uptrend, downtrend and flat) given below.

An uptrend can be identified by drawing an upward trend line by joining the higher low points. A downtrend can be identified by finding lower high points or by drawing a downward trend line by joining the lower high points. When the price lies between a horizontal support and resistance lines, then it is considered as a flat trend.

History tends to repeat itself:

This is another basic assumption of technical analysis. Technical analysts believe that history tends to repeat itself in the present and future price movements. This repetition may not be done in exact price or exact time. Usually history repeats itself in forms of chart patterns or situation. These chart patterns and the situation can be found in past, present and future. Some patterns and situations are bullish in nature and responsible for positive price movements. Some chart patterns are bearish in nature and responsible for negative price movements.

Summary:

Technical analysis is not an exact science. So, you cannot win every time you trade with technical analysis, but most of the trades will be winners as technical analysis increases the winning probability. There are different styles and trading methods in technical analysis and traders should choose among these according to their trading personality. Money management and trading psychology play a vital role behind trading success. Using technical analysis without discipline and proper money management will lead you to the losing side in the long run.

What is Fundamental Analysis?

Fundamental Analysis Basics

Fundamental analysis attempts to determine the value of a company by analysing the financial data from the annual report and using other qualitative data about the company and the environment in which they operate. This value is often called 'intrinsic value'.

Fundamental analysis assumes that over the long term, a stock price will reflect the company's intrinsic value.

Definition

A sound fundamental definition comes from Investopedia.  They define fundamental analysis as:

A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic, financial and other qualitative and quantitative factors. Fundamental analysts attempt to study everything that can affect the security's value, including macroeconomic factors (like the overall economy and industry conditions) and company-specific factors (like financial condition and management).

Quantitative analysis

Fundamental factors that are capable of being measured or expressed in numerical terms form the quantitative measures component of fundamental analysis.

Fundamental analysts focus on the underlying business of the company being evaluated and specifically look at quantitative measures such as:

• Revenues
• Earnings
• Assets
• Debts

These financial measures are often combined to produce fundamental or financial ratios that analysts can use to compare the company they are analysing to:

• other companies in the same industry
• the overall market
• previous periods results for the same company.

Ratios that you may be familiar with include:

• Dividend yield
• Price to earnings ratio (PE)
• Return on equity (ROE)

Qualitative analysis

Qualitative information that can’t be expressed in numbers but relates to the nature of the company itself is also very important in assessing the future performance of a company.
Types of qualitative information may include:

• management performance and experience
• competitive advantage
• business model
• branding.

Pros & cons

Let's explore the advantages of fundamental analysis:

Objectivity	Uses sound mathematical and statistical principles to produce ratios so that there is no room for personal bias.
Long term focus	Markets are usually driven by fundamental factors over the long term. Fundamental analysis can look at  long-term economic, demographic, technologic or consumer trends.
Value	By determining an intrinsic value, fundamental analysts can determine appropriate buy prices that represent 'good value'.
Increased understanding	Research into fundamentals provides the investor with a better understanding of the company and its business.
Sleep at night factor	Investors know that they are investing in fundamentally sound companies because they have done their 'due dilgence' analysis.

Now let's look at some of the disadvantages of fundamental analysis:

Time consuming	Fundamental analysis can be hard work and be overly complicated.  Given the time and difficulty contraints, it may be difficult to get an edge.
Market sentiment	In the short term, markets will not always move in the same direction as fundamental value meaning that often short term momentum will overide the fundamentals.
Timing	Six monthly issuing of financial information may mean a company's fundamentals have significantly changed and means a time lag for investment decisions.  This appplies especially to a lack of opportunity to react quickly to exit stocks.
Based on assumptions	Fundamental analysis for future estimated value can only be based on assumptions so a best and worst case valuation model may need to be considered.  No valuation model can take into account any unexpected negative economic, political or legislative changes.  Another important point to consider is that most information considered in fundamental analysis comes from the company itself and assumptions have to be made that the company is providing accurate and true information.

   

What is Sentimental analysis ?

Sentimental analysis is a bit more delicate substance than Technical and Fundamental analysis. Although technical analysis tells us that “price includes all available information” and that price is all trader’s need to make a deal decision – things are not so simple. We will not debate now on does price really reflect all available information or not – let’s assume that it does, but this point doesn’t mean that all traders open positions in the same direction. Of cause every trader sees the direction of the market, but almost everyone has its own explanation why does market move particularly this way.

But take a look at this moment from different side – maybe the market moves in this particular way (up or down), because it just mirrors what all traders think about it. Each trader opens positions according to his or her own thoughts and opinions about the market, and, it fact, all these positions create that substance that we call market sentiment.

Also to point out that sentiment analysis is closely linked with fundamental analysis, because it’s very often that sentiment forms under some fundamental factors affect. 

The questions is, "It sounds like talks from another world. What is the practical application of this stuff ?" 

The Answer is, " it’s very simple. For example, you are extremely bullish on some currency, say, EUR, but the market has a bearish sentiment – then the market will go down, and you can do nothing here. It’s a pity, but it’s true.
And there is a simple conclusion to us – you can’t for any reason ignore the market sentiment and have to take it into account and include it somehow in your trading strategy. If you will not do that – it will cost you money.
Later we will discuss how to analyze market sentiment so you can use it in your own favor.

Fundamental Analysis vs Technical Analysis

Fundamental analysis and technical analysis are two different methods of analysis. There is a major controversy between these two analytical methods. Some think the fundamental analysis more effective than technical analysis. On the other hand some traders think technical analysis is more effective than fundamental analysis. The debate between technical and fundamental analysis is incomplete as it depends on traders or investors choice.

Difference between Fundamental and Technical Analysis:

There are many differences between technical and fundamental analysis. We will discuss about some of the major differences here. These major differences are given below.

Definition:

By definition, fundamental analysis is a method of analysis which measures the value of the currency of a country using economic factors or fundamentals. On the other hand, technical analysis gauges the future possible price movements analyzing the price movements and patterns.

Data sources:

Economic reports and press releases are the required data for fundamental analysis. On the other hand, charts are data sources for technical analysis.

Function:

Fundamental analysis is very useful for long term investment while technical analysis is very popular for short term trading.

Entry decisions:

Investors use fundamental analysis to take investing decisions based on future value of the currency due to the economic changes. Traders, who use technical analysis to take trading decisions, sell higher than his bought price.

Time frame:

Investors enter into a pair for long term (more than a year), while technical analysts hold a pair for short term (not more than 90 days).

Concepts used:

Fundamental analysts focus on the gross domestic product (GDP), retail sales, consumer price index (CPI), industrial production etc. Technical analysts focus on trends, support-resistance, chart patterns etc.

Which one should you use?

Now the question is which one should you follow, fundamental analysis or technical analysis. Both fundamental and technical analysis is effective for Stock, Commodities and forex trading. It depends on you and your personality that which type of analysis is suitable for you. If you are a long term investor then you should focus on the fundamental aspects and if you are a short term trader then technical analysis will fit with you.

Both of these two methods of analysis have advantages and disadvantages, but these two methods can be combined to get better results in Stock, Commodities and forex trading. Every move of the market can be explained by both fundamental and technical analysis. For example, USD/JPY rally of 2012-13 can be explained by both technical and fundamental analysis. Monetary easing were two major reasons for the rise of USD/JPY as JPY got weaker for last one year. This major economic impact leads USD/JPY to a strong bullish trend as per technical analysis. Upward EMA30 showing the long term bullish trend in the daily chart of USD/JPY (given below).

Fundamental analysis can help us to predict the direction of the major price movements. Then, we can confirm the major movement by technical analysis using trend lines, moving averages, breakouts and can also detect buy and sell signals. So, a trader can use fundamental analysis, technical analysis or both in a combination in Stock, Commodities and forex  trading. But one should use the method of analysis based on his personality, trading style and expectations.

                           

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Types of Charts

Technical traders require technical charts for Stock, Commodities and Forex market analysis for trading. A technical analyst understands the movement of the market and takes trading decision by observing these charts. There are different types of technical charts. Three types of charts are mostly used in Stock, Commodities and Forex market analysis. These charts are,

Let's take a look at the three most popular types of charts:

 

1. Line chart
2. Bar chart
3. Candlestick chart

Now, we'll explain each of the charts, and let you know what you should know about each of them.

1. Line Charts

Line Chart:

Line chart appears as a line which is developed by joining the closing prices. This type of chart is particularly useful to observe and understand the trends of the market quickly. This chart is helpful for understanding the major movements only. It is not suitable to take trading decisions by this type of chart. However, this line chart can generate buy and sell signals when crossovers with moving averages occurs. Here is an example of a line chart given below.

2. Bar Charts

A bar chart is a little more complex. It shows the opening and closing prices, as well as the highs and lows. The bottom of the vertical bar indicates the lowest traded price for that time period, while the top of the bar indicates the highest price paid. The vertical bar itself indicates the currency pair's trading range as a whole. The horizontal hash on the left side of the bar is the opening price, and the right-side horizontal hash is the closing price.

Here is an example of a bar chart  

Take note, throughout our lessons, you will see the word "bar" in reference to a single piece of data on a chart.
A bar is simply one segment of time, whether it is one day, one week, or one hour. When you see the word 'bar' going forward, be sure to understand what time frame it is referencing.
Bar charts are also called "OHLC" charts, because they indicate the Open, the High, the Low, and the Close for that particular currency. Here's an example of a price bar:

Open: The little horizontal line on the left is the opening priceHigh: The top of the vertical line defines the highest price of the time periodLow: The bottom of the vertical line defines the lowest price of the time periodClose: The little horizontal line on the right is the closing price

3. Candlesticks Charts

Candlestick chart show the same information as a bar chart, but in a prettier, graphic format. Candlestick bars still indicate the high-to-low range with a vertical line. However, in candlestick charting, the larger block (or body) in the middle indicates the range between the opening and closing prices. Traditionally, if the block in the middle is filled or colored in, then the currency closed lower than it opened. In the following example, the 'filled color' is black. For our 'filled' blocks, the top of the block is the opening price, and the bottom of the block is the closing price. If the closing price is higher than the opening price, then the block in the middle will be "white" or hollow or unfilled. 

Here at  we don't like to use the traditional black and white candlesticks. They just look so unappealing. And since we spend so much time looking at charts, we feel it's easier to look at a chart that's colored. A color television is much better than a black and white television, so why not splash some color in those candlestick charts? We simply substituted green instead of white, and red instead of black. This means that if the price closed higher than it opened, the candlestick would be green. If the price closed lower than it opened, the candlestick would be red. In our later lessons, you will see how using green and red candles will allow you to "see" things on the charts much faster, such as uptrend/downtrends and possible reversal points.
For now, just remember that we use red and green candlesticks instead of black and white and we will be using these colors from now on. heck out these candlesticks...! Awww yeeaaah! You know you like that!

Here is an example of a candlestick chart  

The purpose of candlestick charting is strictly to serve as a visual aid, since the exact same information appears on an OHLC bar chart. The advantages of candlestick charting are:

• Candlesticks are easy to interpret, and are a good place for beginners to start figuring out chart analysis.
• Candlesticks are easy to use! Your eyes adapt almost immediately to the information in the bar notation. Plus, research shows that visuals help in studying, it might help with trading as well!
• Candlesticks and candlestick patterns have cool names such as the shooting star, which helps you to remember what the pattern means.
• Candlesticks are good at identifying marketing turning points - reversals from an uptrend to a downtrend or a downtrend to an uptrend. You will learn more about this later.

Now that you know why candlesticks are so cool, it's time to let you know that we will be using candlestick charts for most, if not all of chart examples on this site.

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Support and Resistance

Support and resistance is one of the most widely used concepts in trading. Strangely enough, everyone seems to have their own idea on how you should measure support and resistance.

Let's take a look at the basics first.

Look at the diagram above. As you can see, this zigzag pattern is making its way up (bull market). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.

As the market continues up again, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time. The reverse is true for the downtrend.

Like the concept of trend, support and resistance is one of the major concepts in trading. Support and resistance are psychological price levels where forces of supply and demand meet.

At support line demand starts to increase and supply starts to decrease. This is a buying pressure. Inversely at resistance line, supply starts to increase and demand starts to decrease. This situation is a selling pressure.

Support and resistance lines are horizontal straight lines. There is no exact or accurate method to draw support and resistance lines. Thus, a trader’s drawn support and resistance lines might not match with other traders completely. Thus, support and resistance lines are drawn by taking best possible high and low points, in this case some traders might consider the lowest and highest points of candlesticks where some others might consider open and close price of candlesticks in low and high points of a trend.

Support line is a psychological price level where price gets strength and become bullish when price comes near or at this line. Inversely, when price gets near resistance line, it gets weakness. As a result, price movements become bearish.

Support and resistance can be used in 3 ways.

1. Reversals
2. Breakouts
3. Pullbacks

Reversals:

Support should be considered as a base level of price from which price tends to bounce from this line and becomes bullish or buyer dominant (Bullish reversal). Resistance should be considered as a binder near which price gets a resistance force in its upward move and this bullishness of the price becomes weak. As a result as the price comes near resistance line it starts falling as price tends to become bearish near or at this resistance line (Bearish reversal).

Here are some examples-

 In the chart above, we can see the support and resistance line have drawn in the chart of AUD/USD currency pair. Support line is a combination of last two low points. Inversely, resistance line is a combination of two high points. First we have to draw these lines. Trading opportunities occur as the price comes near these lines.
As price gets near support line, we should look for a long position as most of the cases price tends to become bullish at or near this support line. In the chart given above, we can see that AUD/USD has got support twice (blue colored circles near support line) from this support line and started a significant upward movement.
Inversely, when price or candlestick went near or at resistance line, it has got weakness or bearishness as that resistance line worked as a binder or resistance and hence price started falling. So we should look for long position opportunity as the price is near or at support line and look for short position opportunity when price is near or at resistance line. When price moves in between support and resistance line repeatedly then it is trading zone or flat zone where there is no significant trend.
This trading zone becomes more profitable for trading by using support and resistance lines when the trading zone or range is wide or broad. Breakout possibility is high when this trading range or zone is narrow. Here is an example.
Breakouts:
It is not necessary for the price that it will always turn into bullish trend when comes near or at support line and will turn into bearish trend when price comes near or at resistance line. Sometimes price may break these support and resistance lines.
We call it breakout when price breaks out the resistance line and keep its bullish movement intact and breakdown when price breaks the support line and keep moving in its previous bearish trend. Thus, price ignores the reversals near or at support or resistance lines.
These breakouts can be traded effectively and profitably. Breakouts are the strong signal of a major trend. When price or candlestick lies between support and resistance lines, then there is no trend lies there, or it is a trading zone or ranging zone. As soon as price breaks out the resistance line, the currency pair moves into the uptrend or bullish trend and then price tends to remain in this uptrend for prolonged time.
If price breaks down the support line then currency pair has moved into a downtrend or bearish trend and then price tends to remain in downtrend for a prolonged period.
Here is an example of bullish breakout or resistance line breakout.

 In the chart given above, we can see a successful breakout in the daily chart of GBP/USD. Here, we can see the support and resistance lines and then a breakout of resistance line (blue colored circle). Remember that it is necessary for a candle or price to breakout the resistance line with a strong bullish candle, otherwise the breakout may not be successful and can be turned as fake-out (when breakout fails and come back into the trading range within a short time).
So it is mandatory for the price to or candlestick to show good strength when resistance breakout happens otherwise there is a high possibility of fake-out. We should take this resistance breakout as an entry signal for taking a long position.
Now, let’s take a look into support line breakdown. Here is an example,

In the chart given above, we can see the support and resistance line and a breakdown of the support line (blue colored circle) in the daily chart of AUD/USD. This is an example of successful breakdown as the support line has broken down with a heavy bearish candle and thus the downtrend continued vigorously.

In case of breakdown or support line breakout, there should be a strong or heavy bearish candle; otherwise there is a chance of fake-out. We should take this support line breakdown as an entry signal for taking a short position.

Pullbacks:
After a successful resistance breakout, the broken resistance line becomes support line and the price has a tendency to retrace to this new support line (broken resistance). Thus, price tends to pullback or bounce back into the bullish trend again. Inversely, when support line breaks successfully, this broken support line becomes new resistance and price intends to retrace to this new resistance and then bounce back into bearish trend.

In the chart above, we can see support and resistance lines including broken resistance/new support lines in the daily chart of USD/CAD. Every breakout has changed the previous resistance as a new support. Here, we can see 2 successive breakouts thus 2 resistances has become new support. Another important thing is; after a breakout price has retraced back near or at the new support line. Then bounced back to its previous trend as it has got support/strength from the support line. There are two pullbacks shown in this chart.

Now let’s take a look at the example of bearish pullback after a successful breakdown.

In the chart above, we can see support and resistance lines including broken support/new new resistance lines in the daily chart of USD/CHF. Every breakdown has changed the previous support line as a new resistance. Here, we can see 2 successive breakdowns thus 2 support lines have become new resistance. Another important thing is after a breakout price has retraced back near or at the new resistance line and then bounced back to its previous trend (Downtrend) as it has got resistance/binder from the resistance line. There are two pullbacks shown in this chart. Note:

Each three methods of using support and resistance line is effective and profitable. A trader should use it according to his own choice and should consider that the method he/she is using is suitable with his personality or not. For an example, you have to deal with price hike/high volatile condition and as per pullback method during breakouts. Most of the times price tends to retrace after a breakout or breakdown.

So breakout trading requires patience, and flexible stop loss/wide stop loss range otherwise it might not be profitable enough. Reversals are effective for short term trading. Breakouts and pullbacks will work well in trending condition rather than ranging condition

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Trend Lines

What is a trend

A trend is simply, the persistence of a security's price to move in a particular direction. A trend can be bullish, bearish or flat. Also, a trend is in effect till it is reversed. Markets are either bullish, bearish or flat. However markets never go up or down in a straight line. There are always corrections (in bullish markets) and pullbacks or relief rallies (in bearish markets). By identifying trends and reversals, you can enter and exit trends at the correct time and earn excellent profits with minimum risks.

Trend Lines

Trend lines are probably the most common form of technical analysis. They are probably one of the most underutilized ones as well. If drawn correctly, they can be as accurate as any other method. Unfortunately, most traders don't draw them correctly or try to make the line fit the market instead of the other way around. In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

Types of Trends

There are three types of trends:

1. Uptrend (higher lows)

1. Downtrend (lower highs)

1. Sideways trends (ranging)  

How to Draw Trend Lines on a Stock Chart ?

Drawing trend lines is an art form that can take awhile to master. That's because everyone has their own unique way of drawing them! There is no perfect way to draw them and it seems that no one can agree on the best way! 

To draw trend lines properly, all you have to do is locate two major tops or bottoms and connect them.

What's next?

Nothing....... is that it?

Yes, it's that simple.

Here are trend lines in action! Look at those waves!

Drawing trend lines
The chart below shows an example of a trend line in a downtrend and an uptrend.

number_1 Shows three swing highs on the downtrend
number_2 Shows three swing lows on the uptrend

When drawing trend lines in a downtrend, you draw them above the price.
You can practice identifying trend lines in the following exercise:

Using the wicks or bodies of the candles, which of the following trend lines is correctly drawn on this downtrend?
number_1

number_2

number_3

Solution

The solution is number_2

Drawing trend lines can be tricky and must be done correctly in order to trade with them. Remember that in a downtrend you always draw trend lines above the candles. In chart number_2 we see price testing as resistance the trend line 3 times.

When you draw trend lines in an uptrend, you draw them below the price. It is the highs on a downtrend and the lows on an uptrend that will determine a trend line.
You can practice identifying trend lines in the following exercise:
At least two swing highs or swing lows are needed to draw a trend line in either direction.
However, for a trend line to be valid, at least three highs or lows should be used. Essentially, the more times the price touches a trend line, the more valid it is, because there are more traders using them as support or resistance.
Using the wicks or bodies of the candles
To draw trend lines, some traders use the bodies of the candlesticks, while others prefer the wicks. While the majority of people will use the wicks to draw trend lines, the use of the bodies is an acceptable way to draw trend lines on a chart.
The chart below shows a trend line drawn using the wicks of the candlestick.

The next chart below shows a trend line drawn using the bodies of the candles. Either of these are acceptable.

Trend lines are subjective, so use what you feel comfortable with. However, it is important not to deviate from the method that you choose.
Using trend lines to trade
There are two predominant methods in which to trade using trend lines:

• Entering when the price finds support or resistance at the trend line

• Entering when the price breaks through the trend line

Trend line as support or resistance
If a trend line has been identified and it is holding as support or resistance, then you can use the trend line to enter into the market once the price comes back to it.

es1 Short entry after the price finds resistance at the trend line
sl2 Stop loss above the trend line
The chart above shows the trend line being used as resistance and the price using it to find an entry.
A stop loss can be put on the other side of the trend line. The size of the stop loss depends on the strategy involved.
Trend line break
The trend line break method uses the actual breakout of the line to determine an entry. When the price breaks through a trend line, it is no longer valid as support or resistance and it is likely that the price will continue to reverse direction.
There are two ways to enter using a trend line break: an aggressive entry and a conservative entry.
An aggressive entry
An aggressive way to enter using a trend line break is to enter as soon as the candle breaks through and closes on the other side of the trend line.

es1 Short entry after the price broke through the trend line to the downside
sl2 Stop loss is placed above the trend line
The chart above demonstrates that once the candle closes on the other side of the trend line, then you can enter immediately. A stop loss can be placed on the other side of the trend line.
A conservative entry
A more conservative way of trading the trend line break is to wait until the price has broken through the trend line and then tested from the other side as either support or resistance.

number_1 Price breaks through the trend line to the downside
number_2 Wait for the price to come back to the trend line and find resistance
es3 Once determined that the breakout is true, enter into a short entry
sl4 Stop loss is placed above the trend line
The chart above shows a trend line that has been broken after acting as support. The price then tested it from the other side as resistance, further confirming that the breakout is likely to continue. After the trend line has been tested as resistance, you can enter a short position and place a stop loss on the other side of the trend line.
Caution using trend line breaks
In order to trade a breakout of a trend line, it is a good idea to wait until a candlestick actually closes on the other side, or tests the other side of the trend line as either support or resistance. Without a close on the other side of the trend line, it is generally not considered an actual break.

number_1 False breakout
In the above chart, the price moved below the trend line. However, it retraced and the candlestick closed above the trend line. If a trader entered as soon as the price broke through, it would have been a losing trade.
Summary
So far, you have learned that ...

• ... trend lines are drawn at an angle and are used to determine a trend and help make trading decisions.

• ...in an uptrend, trend lines are drawn below the price and in a downtrend, trend lines are drawn above the price.

• ... to draw a trend line in an uptrend, two lows must be connected by a straight line.

• ... to draw a trend line in a downtrend line, two highs must be connected by a straight line.

• ... a trend line should be connected by at least three highs or lows to make it valid.

• ... the more times the price touches the trend line, the more valid it is.

• ... trend lines can be used as support or resistance, in which case you can enter trades when the price touches the trend lines.

• ... another way to trade using trend lines is a trend line break, where the price breaks through the trend line.

1. Here are some important things to remember about trend lines:

1. It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.

1. The STEEPER the trend line you draw, the less reliable it is going to be and the more likely it will break.

1. Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.

1. And most importantly, DO NOT EVER draw trend lines by forcing them to fit the market. If they do not fit right, then that trend line isn't a valid one!

In conclusion...
I have a confession. I don't draw trend lines very often! After you have looked at thousands of charts, you can see them without having to actually draw them in. And I certainly would never buy a stock just because it is hitting a trend line.
They are just a piece of the puzzle.

3 Tips For Trendline Trading

Trendlines are a staple for technical traders that can be used on any currency pair and on any time frame. Follow these 3 easy steps to drawing trend lines which is a powerful tool to time entries and exits of a trade. A trendline is probably the most basic tool in the technical trader’s toolbox. They are easy to understand and can be used in combination with any other tools you might already be using. By definition, a trendline is a line connecting two or more lows or two or more highs, with the lines projected out into the future.Ideally, traders look at these extended lines and trade on prices reacting around them, either trading a bounce of the trendline. So, what can we do to make sure the trendlines that we've drawn are sound?

Tip #1 – Connect Swing Lows to Swing Lows (or Swing Highs to Swing Highs) We want to draw a line connecting either two (or more) swing lows or two (or more) swing highs. For those unfamiliar with the term swing highs/lows, we simply mean the peaks and valleys created with zig zagging prices. Once we connect peaks with other peaks or valleys with other valleys, we want to see the line not being broken by any candle between those two points. Take the examples below.  

Learn : Draw Unbroken Trendlines

In the first image, you will find that we successfully drew a line connecting two swing lows. But, between those two points, the price broke through the line that we drew. This invalidates the trendline.

What we want is what we see in the second image, two swing lows connected together by a line unbroken by price. This is a valid trendline that is ready to be projected out into the future.

Next time price gets near this trendline, we will want to look for a bounce. A convenient way of trading this type of setup is using Entry orders. Entry orders can be set to get you into a trade at a specific price.

I like to set my Entry orders several pips above a support trendline or several pips below a resistance trendline. That way if the price reacts before getting to the trendline, I still have a chance at getting into a trade. You have to remember that if there are many traders looking at the same price to act as support/resistance, there is a chance that orders will be stacked around these levels. If there are enough orders keeping the price from getting to the trendline, the price might not get to you order if it’s placed directly on it.

 

Tip #2 – The More Connecting Points, the Better

 

You've probably noticed that I have referenced two or more highs/lows make up a trendline. The reason I mention "or more" is because trendlines can continue to be relevant far out into the future and can be bounced off of several times. As a general rule of thumb, the more times a trendline has been hit and respected with a bounce, the more important the market believes that it is. Like anything, however, trendlines cannot last forever. So after a multitude of bounces, one has to expect a break to eventually occur.

The first reason this is true is that you can draw a line connecting any two points on a chart. Just because there were two distinct highs in the last 50 bars and you drew a line between them doesn't actually mean the line is a valid trendline. What you would have is a potential trendline.

To truly validate a trendline, you need to see the price actually react from a line projected from a trendline drawn based off of two prior points. Essentially, a third high/low is needed to truly solidify a trendline. Once you have this, you can then feel better about looking for opportunities to exploit the market when price reaches the trendline again. While having a third high/low is recommended before looking for a trade, it is not required. Aiming for an entry on point #3 below could work out just fine.

Learn: Validate Trendlines

 

Each time you see the price bounce off the same line, the more likely it is that others are watching it too and are playing the same game you are. This could help you get several good entries in a row, but remember trendlines won't last forever. So you want to make sure you set proper stop losses to get you out quickly if the support/resistance trendline eventually fails.

Tip #3 – Buy Bullish Trendlines, Sell Bearish Trendlines

 

The trend is your friend! This steadfast rule also applies to trading trendlines. For experienced traders, this basically means we should only look to buy at bullish support lines and sell at bearish resistance lines. For traders not into trading jargon, let the following images below explain this to you.

 

Learn : Buying Bullish Support Trendlines

 

An upward slanting (bullish) trendline means the price has been trending up, so we want to look for buying opportunities. Buying opportunities occur when the price drops down and comes close to the trendline that has caused upward bounces before.

 

Learn : Selling Bearish Resistance Trendlines

 

A downward slanting (bearish) trendline means the price has been trending down, so we want to look for selling opportunities. Selling opportunities occur when the price moves up and comes close to the trendline that has caused downward bounces before.

Trading only in the direction of the trend well let us exploit potential trendline bounces as efficiently as possible. And while they won't always give us winning trades, the trades that are winners should give us more pips than had we been attempting to place trades against the trend.

(Note: There is also the potential to trade a break of a trendline rather than a bounce, but that is a more advanced technique. This is something to be covered in a future article.)

Connecting the Dots

Coming full circle, trendlines are a very simple tool to use. You are connecting dots on a chart. But hopefully the 3 tips above will help you take drawing trendlines to the next level. Make sure that the lines you draw are connecting two or more highs or two or more lows, but have not been broken by the price between those points. Remember to look for at a 3rd bounce to validate a trendline. Also, make sure you are taking advantage of trading with the trend by looking for buys in bullish markets and sells in bearish markets.

Overall, I hope this makes you more confident in drawing trendlines. Good trading!

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