Theory of Price Action
Master the 10 core academic lectures of technical analysis and investor psychology.
Lecture 1
What is Technical Analysis?
Foundation & Philosophy
Technical analysis is the study of market behavior through charts, patterns, and mathematical indicators. It assumes that all relevant information is already reflected in prices and that prices move in trends that can be identified and exploited.
Fundamental Principles
1. Market action discounts everything: price already reflects all information. 2. Prices move in trends: trends persist until they reverse. 3. History repeats itself: human behavior/cycles are consistent.
Behavioral Link
Technical analysis focuses on HOW investors behave rather than WHY prices move. It complements fundamental analysis by quantifying greed, fear, and panic into predictable formations.
Core Principles
Market action discounts everything: Price already reflects all available information.
Prices move in trends: Trends tend to persist until they clearly reverse.
History tends to repeat itself: Human behavior remains consistent over time.
Technical tools turn historical price/volume into actionable insights. Because many traders use the same tools, their expectations can become self-fulfilling prophecies.
Theory Engine v5.0
Lecture 2
Candlestick Charts & Formations
Visualizing Market Sentiment
Originating in 18th-century Japan for rice trading, candlesticks provide insight into market sentiment. They represent four key data points: Open, High, Low, and Close.
OHLC Structure
Open, High, Low, and Close. The body represents the range between open and close. Wicks (shadows) show price extremes and 'rejection' of certain levels.
The Rejection Logic
Long upper shadows show rejection of higher prices (bearish pressure). Long lower shadows show rejection of lower prices (bullish pressure).
Doji
Open and Close are nearly the same. Signals extreme indecision and potential reversal.
Hammer
Small body near the top with a long lower shadow. Bullish reversal after a downtrend.
Engulfing
A larger candle that fully consumes the previous body. Marks a powerful sentiment shift.
Morning Star
Three-candle reversal: Bearish candle, indecisive star, then strong Bullish candle.
Theory Engine v5.0
Lecture 3
Renko Charts
Price-Based Trend Identification
Renko (from 'renga' meaning brick) charts filter out noise by disregarding time. A new brick is only added when price moves a predefined 'brick size'.
Dynamic Brick Sizing (ATR)
Traders often use the Average True Range (ATR) to set brick sizes. This allows bricks to expand during volatility and contract in quiet markets, aligning sensitivity with current conditions.
Trading Signals
Consecutive green bricks signal an uptrend, while a color change (green to red) suggests exhaustion and potential reversal. Horizontal brick clusters form clear support and resistance zones.
Theory Engine v5.0
Lecture 4
Moving Averages
Smoothing the Noise
Moving Averages (MAs) smooth price data to reveal underlying trends. They are simple, transparent, and core to trend-following systems.
SMA & EMA Calculations
10-day SMA = (Sum of last 10 closes) / 10. Suppose closes are: 100, 101, 99, 98, 100, 102, 103, 104, 105, 106. SMA = 101.8. The EMA applies a multiplier alpha = 2/(N+1). EMA10 reacts quicker because alpha concentrates on the latest price.
The Crossovers
Golden Cross: 50-day SMA crosses above 200-day. Death Cross: 50-day SMA crosses below 200-day. These define the market regime (risk-on vs risk-off).
Theory Engine v5.0
Lecture 5
Bollinger Bands
Volatility-Based Trading
Developed by John Bollinger, these consist of a 20-period SMA flanked by two standard deviation bands. They adapt automatically to shifting market volatility.
The Squeeze & The Walk
Band Contraction (Squeeze) signals a calm before a storm (breakout). Band Expansion signals a strong, trending market. Hugging the upper band is known as 'walking the bands'.
Mean Reversion
Prices tend to revert to the middle SMA after touching either band. In sideways markets, buy near the lower band and sell near the upper band.
Theory Engine v5.0
Lecture 6
Relative Strength Index (RSI)
Momentum Oscillator
RSI measures the speed and magnitude of recent price changes. It oscillates between 0 and 100, traditionally marking 70 as overbought and 30 as oversold.
Relative Strength Formula
RSI = 100 - [100 / (1 + RS)], where RS = (Average Gain / Average Loss). Above 70 is overbought; below 30 is oversold. Divergences warn of possible reversals.
Centerline Behavior
Crossing above 50 suggests bullish momentum; below 50 suggests bearish control. Many traders use trendlines directly on the RSI indicator.
Theory Engine v5.0
Lecture 7
MACD
Momentum & Trend Convergence
Moving Average Convergence Divergence measures the distance between two EMAs (12 and 26). A signal line (9 EMA of MACD) provides entry and exit triggers.
The Histogram
The histogram visualizes the gap between the MACD and Signal line. Widening bars show strengthening momentum; contracting bars suggest trend exhaustion.
Crossover Signals
Buy when MACD crosses above the Signal line (bullish). Sell when it crosses below (bearish). Zero-line crossovers confirm the trend's primary direction.
Theory Engine v5.0
Lecture 8
Fibonacci Retracement
Support & Resistance Geometry
Markets often retrace a predictable portion of a move before continuing. Fibonacci levels help identify these 'hidden' support and resistance zones.
Key Ratios
Common levels: 23.6%, 38.2%, 50%, 61.8%, and 78.6%. The 61.8% 'Golden Ratio' is the most watched level globally.
Practical Execution
Draw from swing low to swing high in an uptrend. Look for buys at the 50%-61.8% zone. Align with moving averages for 'confluence' (higher probability).
Theory Engine v5.0
Lecture 9
Momentum vs Contrarian
Opposing Trading Philosophies
Momentum assumes 'the trend is your friend' until the end. Contrarian assumes markets overreact and will snap back (mean reversion).
Wald-Wolfowitz Runs Test
Evaluates if a sequence is random. Calculation: E[R] = (2n1n2/n) + 1. Few runs (clusters) = Trending. Many runs (flips) = Range-bound noise.
Regime Filtration
Momentum is fueled by herding and underreaction. Contrarian profits from overreaction. ADX helps decide when to follow or fade recent movements.
Theory Engine v5.0
Lecture 10
Average Directional Index (ADX)
Trend Strength Gauge
Developed by Welles Wilder, ADX measures trend strength regardless of direction. It prevents traders from using trend-following tools in sideways markets.
Interpretation
ADX > 25: Market is trending. ADX < 20: Market is range-bound/choppy. Rising ADX confirms trend momentum; declining ADX suggests weakening trends.
Directional Bias (+DI / -DI)
Positive Directional Indicator (+DI) captures upward pressure. Negative (-DI) captures downward pressure. The ADX line itself has no directional bias.
Theory Engine v5.0
Mastery requires
discipline
By completing these theoretical foundations, you have moved beyond speculation and into the world of data-driven investment logic. Technical analysis is your map; execution is your journal.