So what are the four basic principles of technical analysis?
The list consists of the basic principles of market behavior compiled from the accumulative knowledge of successful traders.
The first principle of technical analysis; markets alternate between range expansion and range contraction
The market structure can be either trending or chopping back and forth in ranges. Not all trading tools work in different market structures.
For example, when the market structure is in a trading range, a trading strategy using technical analysis that sells resistance and buys support will provide results. But if the market structure is trending rather than range, then that strategy will fail.
So zero in on the price chart and determine whether the market is range-bound or trending.
“The market structure can be either trending or chopping back and forth in ranges. Not all trading tools work in different market structures”
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Trend continuation is more likely than reversal is the second basic principle of technical analysis
So going with the flow, the momentum is more likely to make profits than betting against the trend.
While contrarian trading can lead to spectacular wins, few traders have the resources and stamina to hang onto losses waiting for the trend to pivot in their favor.
Trends end with a climax, or a rollover is the third basic principle of technical analysis
There are predictable patterns to the ways trends end. Either the market runs out of steam, resistance starts to hold, and the market rolls over. The “rounding top” formation is the pattern to look for when momentum rounds out. A buying climax looks like an inverted vertical spike, where buyers want to get in on any price. Everyone thinks they are getting a trip to the moon.
Once that last buyer buys, a vacuum is created on the other side, and the market collapses.
“There are predictable patterns to the ways trends end”
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Momentum leads price, the fourth principle of technical analysis
This principle is considered the most important of the four by successful technical analysis traders.
So the basic unit of market movement is a move in one direction, a pause and a smaller move in the opposite direction, and then another move in the original direction.
This pattern is where momentum leads to price repeats in various time frames.
This principle of momentum leads to price implies that mean price action moves sharply, when you see an “impulse” or “momentum” move, price is likely to continue in the same direction. But this rule doesn’t refer to indicators that measure momentum lead price.
So, frankly, there are no leading indicators, bearing in mind that all standard indicators are derivatives of price.
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