Guest Post by Aamar Hussain is the Chief Technical Analyst and Managing Director of Technical Analysis provider forPivotFarm.com.
Prior to creating PivotFarm.com, Aamar worked as an independent trader and analyst providing research analytics to proprietary firms based in the city of London.
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Most if not at all traders, be they day, swing or buy and holders have come across technical analysis. You know what I’m talking about! Those squiggly lines all the gurus seem to have on their charts! They consist of patterns like the famous ‘Head and Shoulders’, age old equations seen across nature like ‘Fibonacci’, even historic wave movements measured by ‘Elliott Wave’.
As great as the names may sound, most if not all these methods and the many others boil down to one key technical principle ‘Support and Resistance’. Support levels are where demand overtakes supply and Resistance levels are where supply overtakes demand. Most technical analysis methods serve the single purpose of helping traders identify Support and/or Resistance, however the areas these methods predict can vary from method to method.
Within the technical analysis group are two subgroups we call Proactive and Reactive. Proactive technical analysis methods are based upon a calculation derived from price and include Elliott Wave, Fibonacci, Pivot Points and Trend lines and in many cases identify Support and Resistance areas where price has never been before. These methods are predictive based upon the cyclical nature of markets and use this nature to highlight potential areas of price inflection.
Reactive technical analysis methods are the polar opposite they are derived directly from price action and include Price swing highs/lows, Volume profile and Open Gaps. These methods are based upon the direct action of price, levels that were actually traded be it yesterday or 30 years ago. Reactive technical analysis relies upon ‘market memory’ that traders will recognize or respect past areas of price inflection.
Now following on from this logic, if most technical analysis methods are used to identify Support and Resistance, why are there so many different methods? Well one of the main reasons for these adaptations is market personality; the market can go through many distinct personalities or phases. This is why a trading style that’s been profitable for you for the last 3 months may become a loser now that the market ‘phase’ has changed. Markets can go through bullish, bearish, sideways, high volatility, low volatility and every other phase in between.
The Schizophrenic nature of evolving market environments mean that in given phases certain types of technical analysis work better than others. This is where the concept of technical confluence can offer a great edge. Technical confluence much like a rope consisting of multiple strands is the combining and intertwining of multiple technical analysis methods both Proactive and Reactive to create a ‘community’ view. This community view includes ‘market memory’ (reactive) and a cycle based prediction (proactive), these 2 analysis groups offer great insight and confirmation for the savvy trader.
So practically what does this mean? Say for example we analyze a EURUSD futures chart using a few of these methods and find a 50% Fibonacci retrace at 1.4441. a price swing low at 1.4451 and a Low Volume Valley at 1.4445. Based upon the confluence of these methods and the differing trading groups who will be viewing that area, the odds of a reversal in the 1.4441-1.4451 area are stacked in our favor.
Why does this work? Combining multiple methods means combining multiple groups of traders, so more ‘eyes’ on that area. Furthermore the combination and confirmation from multiple methods both reactive and proactive helps traders adapt to changing market phases with more confidence. Probably the most important reason to use Technical Confluence is the dreaded P-word ‘Psychology’. Technical confluence as a psychological edge cannot be emphasized enough, if you are confident and firm in your reasoning for a trade you are much more likely to manage that trade to fruition.
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