Trading on a “gut feeling” is inconsistent and unsustainable over the long run. It is very important to make a habit of market analysis; this is often the best basis for determining when to buy or sell and at what prices to enter and exit the market.

Let’s start off with two definitions:

Fundamental analysis is an attempt to evaluate the underlying value of the asset you are trading and deciding whether it is under- or overvalued at the current price. When analysing stocks and shares, a trader will look at the company’s balance sheet, the health of the industry, and so forth. For forex trading, a trader might evaluate economic data like GDP for various countries to determine likely future moves in the currency. However, forex is not something we will delve into deeply here.

The other way to analyse a market is through technical analysis. This is the examination of historical price and volume data in order to judge future price trends. The main tool used by a technical analyst is the chart.

Price chart types 

Most trading platforms and market intelligence websites make use of 3 main chart types (or chart styles). These are candlesticks, bar charts, and line charts. In each case, price charts are plotted with time on the horizontal axis and value on the vertical axis.

Each chart type shows how prices moved over some period. You can set the time period each chart covers, often selecting between scales ranging from minutes to years. 

Line charts display the closing price for each period. Bar charts and candlestick charts show more information: the opening price, highest price, lowest price, and closing price (collectively known as OHLC) over that same time period.

Volume

Volume can be measured in different ways, but the most common are just the total number of, or value of, contracts that have been traded over a period. The volume is typically plotted at the bottom of the chart as a histogram, and each bar or candle will correspond to one period of the volume histogram. Analysts use the relationship between price and volume to predict future movements in an asset’s price.

Trend analysis

Before any effort is made to understand more complex price patterns and technical indicators, the very first thing any trader must do is determine the current trend in the market. There are mathematical systems to support this effort, but the simplest method is to simply observe the slope of the chart. The chart can only be doing one of three things: trending up, trending down, or moving sideways.

Aside from the slope of the chart, traders can look at what is happening around the turning points, known rather intuitively as “highs” and “lows”. In an uptrend, the price will reach higher highs and higher lows, while an asset trending downward will see lower highs and lower lows.

Momentum

It is time to take a trip down memory lane to your high school science lessons and Sir Isaac Newton. In physics, momentum is the impetus gained by a moving object. In the case of finance, the “object” is an investment’s value. Price momentum is the speed at which the price is changing; though it is not strictly conserved in the mathematical sense, it does tend to be retained. Momentum can be measured by eye, meaning looking at the steepness of the upward or downward slope of a chart, or with mathematical indicators. 

Relating this back to our thoughts on trends, we might say that a particular uptrend is gaining momentum or losing momentum when it is either accelerating or losing steam. This is useful information because, ideally, you want to buy just as the uptrend starts gaining momentum and sell as the price starts to lose momentum. 

Japanese candlestick patterns

The way in which the open, high, low, and closing prices of a stock relate to each other over one or two periods tends to repeat in useful patterns over time. This technique was supposedly first used in Ancient Japan by rice traders, but is now commonplace in modern-day financial markets. These fall into one of three general groups: “bullish reversal”, “bearish reversal”, and “continuation” patterns, each corresponding to certain kinds of market conditions.

Here’s a cheat sheet showing some of the most commonly encountered Japanese candlestick patterns:

Technical indicators

Once a burgeoning investor has a good handle on the main trading tools that use price itself for analysis, they can move on to mathematical equations for what the price has done in the recent or not-so-recent past. These equations and metrics are known as technical indicators. 

As displayed on trading platforms, indicators are split into two main categories: “overlays” and “underlays”. As the names suggest, overlays are simply shown over the chart, while underlays go in a separate box underneath it, as numbers. We’ll look at some examples of each in the following sections. One variation of the underlay is an oscillator, where the indicator is visually represented as a line that varies between (say) -1 and +1.

Moving average

A moving average is simply the average price over the last 20 periods, going back through time. A “period” is defined by the way the chart is shown, so we might speak of 20-hour or 20-day or 20-month moving averages. The current value of the moving average is the mean of the last 20 periods. Of course, when the market re-opens, the average will be recalculated, as price data from 21 days ago will no longer be relevant – hence it being called a “moving” average.

As you can see from the above example, the moving average smooths out random price fluctuations, while its value lags behind the current spot price. This indicator is therefore best used for determining the trend of the market. As long as the market price lies above the moving average and the moving average itself is sloping up, we can say there is an uptrend. While when price is below the moving average and the moving average slopes down, then we’re seeing a downtrend.

RSI

RSI stands for Relative Strength Index. This indicator is an example of an oscillator. It is most often used as a way to determine whether the market is overbought or oversold, or whether prior momentum has gotten overextended in one direction or the other. The RSI can often foretell a snap-back in the price, or a change in momentum. The RSI tends to be best used in rangebound or sideways markets. This is because, in the presence of a firm trend, the market can remain overbought or oversold for long stretches of time.

Another popular way to use RSI is to look for divergence. In other words, when the price reaches a new high in an uptrend or a new low in a downtrend, but the RSI does not, it could well be that the price trend is about to reverse.

MACD

Another popular underlay indicator, though not an oscillator, is the MACD, which stands for Moving Average Convergence Divergence. Like the RSI, this metric can also be used as an overbought or oversold indicator, or to signal divergence. However, it is more commonly applied as a trend-verification tool. If the MACD is over the zero line, it signals an uptrend, whereas a MACD below the zero line generally means a downtrend.

Some traders use the zero line on the MACD as a trigger for opening and closing trades, whereas others prefer to see it as announcing the start and ending of trends, informing the decision of whether they want to be buying or selling.

Conclusion

This guide, of necessity, covered a lot of ground rather superficially. If you still feel like a complete newcomer to investing after reading it, don’t worry – even veteran traders are frequently surprised by how much they still have to learn.

The next steps on your journey to financial freedom should be to open a demo trading account to get yourself familiar with the workings of your chosen trading platform. In its dashboard interface, you’re sure to find many of the things we’ve discussed in this guide. Then, after some practise and experimentation, it will be time to test your wits using a live trading account, where the added stress of having real money on the line will introduce you to the psychological aspects of trading.