While many people are quick to get into online trading, especially on a platform that is as easy to use as eToro, some could find the technical aspects quite daunting. However, technical analysis in financial markets is something worth taking the time to learn, as it is the tool most used by most professional traders.
To make sure your entry into the realm of technical analysis is a smooth one, we’ve created a glossary of terms that will help you in familiarising yourself with the field:
Bollinger Bands are one of the more popular indicators used by traders. Developed by John Bollinger, the Bollinger Bands are created using a 20-day moving average as a central line and two tracing bands in standard deviation width, one below and one above, the centerline acting as an exponential moving average. These are price channels that can be implemented to detect the strength of a trend and time market entries. Bollinger Bands are based on standard deviation, which changes with the increase or decrease in volatility. The bands will expand as the price fluctuates and will contract when momentum, or volatility, decreases. Like other indicators, Bollinger Bands can be used to detect if a financial asset is going to overbought or oversold territory: if the price of the asset goes outside the band’s bounds, it can be considered overbought, while if it remains below the lower band, it can be considered oversold.
EMA (Exponential Moving Average)
EMAs are a basic type of moving average indicators, measuring trend direction over a period of time. EMA gives more weight, or importance, to recent data rather than historical data, while SMA (simple moving average) gives equal weight to all the values. EMAs are commonly used as a technical analysis tool in conjunction with other indicators to confirm significant market moves and to gauge their validity.
The Fibonacci retracement tool is a popular technique, used by traders for technical analysis of stocks, to help predict how high or low a stock’s price will go. Traders will take two extreme points – high and low – on a chart, then divide the distance by the Fibonacci ratios, 23.6%, 38.2%, 50%, 61.8% and 100% in order to discover the vital points where an asset’s price reverses. These numbers are based on the Fibonacci sequence of numbers (1,1,2,3,5,8,13,21, etc.), hence the title given to this indicator. According to this indicator technique, the direction of a previous trend will most likely resume once the price has retraced to one of the Fibonacci ratio numbers.
Ichimoku Clouds are indicator charts used to display Support and Resistance details, as well as stock momentum and trends, all in one screen. If the current price appears above the cloud, the direction of the stock is going up. If the current stock price appears below the cloud, it is in a downtrend. Alternatively, if the colour of the cloud is green, the market is “bullish.” If the colour of the cloud is red, the market is “bearish.” Furthermore, the cloud lines can also be translated as levels of support and resistance. Ichimoku Clouds go further than the current price action, projecting roughly a month ahead of the current stock price. You can read more here.
MACD (Moving Average Convergence Divergence)
MACD is used for technical analysis of stocks. It is an oscillator momentum indicator that helps traders identify trends, directions, momentum and strength in the stock market. It’s also used to confirm trends based on other strategies, while providing users with its own unique trade signals. The MACD is composed of two moving averages: a 12-day average, and a 26-day average. The MACD line moves faster than the signal line, since the latter is a moving average of the MACD line. The MACD also consists of a histogram that fluctuates above and below zero, displaying the extent that the MACD has reached above or below the signal line. In addition, it provides a short-term view of recent momentum and directional change. When the histogram is above zero, recent momentum was higher; below zero, recent momentum was down.
RSI (Relative Strength Index)
The Relative Strength Index is a momentum indicator to measure a stock’s relative strength against its price history. The RSI fluctuates between 0-100, and the stock’s price is recorded over a certain time frame. Increases and decreases in the stock price are recorded on the RSI graph. If an asset’s price value falls below 30, it is considered oversold; if it climbs over 70, it is considered overbought. By using RSI for technical analysis of financial markets, a trader can determine a stock’s profit or loss over a period of time. You can read more about RSI here.
Stoch RSI (Stochastics Indicator)
Stoch RSI is a popular oscillator indicator, created by Chande & Kroll in the book, The New Technical Trader. The aim of this indicator is to create more overbought and oversold signals than the Relative Strength Indicator. Stoch RSI employs RSI values instead of traditional price values. It measures where RSI’s present value stands, relative to its high or low points, for a specific time period. Since it fluctuates between 0-100, it is also referred to as an oscillator. Stoch RSI works by providing traders with overbought and oversold signals: Buy signals are created when Stoch RSI shifts from oversold (under 20) to above 20. Sell signals are formed when Stoch RSI declines from overbought (above 80) to below 80. A financial asset can remain within either the oversold or overbought zone for an indefinite amount of time.
Support and Resistance
Support and resistance are the most commonly used tool for technical analysis in financial markets. They represent key points for investors as to when to open or close a trade. They represent “invisible thresholds” where the investor believes the price will not dip further (support) or does not climb higher (resistance). The support level is where demand for the stock is firm enough to prevent the stock price from dropping further. The logic behind it is that as the price decreases towards the support line and becomes cheaper, more traders will be interested in buying, while sellers will resist selling. When the price reaches the support level, demand would be high enough to prevent the price from dropping further, below the support line. The support line can be broken, which indicates that buyers are still not willing to buy at that price, and sellers are willing to sell at an even lower price, while resistance levels are a so-called “ceiling” that prevents prices from rising higher.
Naturally, the world of trading and investing is vast and the lingo used by traders is quite extensive. The above glossary should give you a great starting point to join the conversation, gain a better understanding of the terminology and start performing technical analysis on your own. To experiment with technical analysis, open a free account with eToro and use the virtual account to practise the different techniques.
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