A few general principles on technical analysis

Technical analysis studies chart patterns, and it aims to identify trends, decide on entry/exit points and determine the psychological attitude of the market environment.

In general, there are a number of points to keep in mind about the suitability of an indicator to a chart pattern.

The first step in performing technical analysis should be the determination of the type of price action that the market is experiencing. Since the conclusions drawn by employing technical analysis often depend on the presumptions made about the type of the market action (whether the market is trending, breaking out, consolidating, or ranging), the trader should carefully study the price chart, and the fundamental factors that influence it, before employing the tools provided by technical analysis.

1. Oscillators are best suited to analyzing ranging markets where the trend is confined and going nowhere. The basic purpose behind the construction of an oscillator is to artificially limit the price action into a predefined range in order to create buy or sell signals, and it’s only natural that oscillators are most effective when the price action is itself in a range.
2. Moving averages are more suitable for the study of trending markets, where the often violent price movements invalidate the signals generated by the oscillators.
3. Support and resistance lines can be very helpful in determining the boundaries of ranging markets, and they can also be helpful in deciding on entry or exit points when the trader desires to join an existing trend. A successful breakout from a well-defined price range can be very powerful and the trader can attempt to reduce the volatility of his portfolio by avoiding trading close to major support or resistance lines when he’s not safe about his analysis or assumptions.
4. Simple trend lines, whether drawn manually or created by moving averages, can be exceedingly useful in reducing the role of speculation in analyzing price action. If, for instance, a moving average of a certain period (like the 100- and 50-day moving averages) provides an insurmountable barrier to the price action for a considerable time, the trader can use it as a naturally occurring trend line without worrying about the intricacies of technical analysis. Conversely, when such a barrier line is invalidated by the price action, the trader can regard this as a signal for a countertrend move. But in all cases, the trader must avoid changing his tools constantly or seeking the best indicator, since this will only cause distraction.
5. And finally, the golden rule of technical analysis is to keep it simple. Even indicators of the same type are prone to creating conflicting signals, and there’s no reason to expect that false signals generated by a multitude of indicators can be combined to create a correct signal (though this may be possible logically, but in practice it’s extremely unlikely). Since we will not know which indicator tells the truth until the price action confirms it, there’s little to be gained by compounding the uncertainty inherent in our analysis by adding to the noise in our data with more and more indicators.