Technical Analysis III: Support and Resistance
What are support and resistance?
Support levels are prices where buyers
have shown or are likely to show strength. Resistance levels are prices where sellers are likely to be strong.
have shown or are likely to show strength. Resistance levels are prices where sellers are likely to be strong.
Support
Support levels essentially give the market a 'floor', since they are areas where buyers tend to be strong. If the price falls to a strong support level, traders should expect buyers to step in and drive the price up, or at least keep it from moving any lower.
Because support levels are prices where buyers are supposed to be strong, if the price falls below a support level, this is a signal for the market. It shows that there is more selling pressure (or less buying) pressure than previously thought, and it often leads more traders to exit long positions and take short positions.
Resistance
Resistance levels perform the opposite function of support, which provide a 'ceiling' to the market. If the price rises to a strong resistance level, short sellers should be expected to enter the market and traders in long positions may cover their positions to take profits. This combination of selling pressure will often drive the price lower.
Resistance functions in the same manner as a safety net for short positions and an entry point for traders looking to buy on a breakout.
When a price breaks through a resistant level, it often triggers a large number of stop orders and makes for even greater buying power. Often the stronger the resistant level, greater the number of stops that are triggered and the larger the move above resistance.
Unfortunately, not every breakout is valid. Because they know that many traders place stops to sell just above resistant levels, some large institutional traders attempt to drive the price higher in the short term just to trigger these stops. Without any real force behind the move higher, the price can fall back to resistance. The same dangers of false breakouts apply to support levels as well.
Technical Analysis IV: Identify the Market Trend
Three Phases of Major Trends
A trend represents a general direction of the market. Dow Theory asserts that major trends have three distinct phases: accumulation, public participation and distribution. The accumulation phase represents the first part of the trend in which those who are well-informed buy or sell. In other words, if the well-informed recognize that the recent downtrend is soon coming to an end, they would buy, and vice versa.
The public participation phase involves the masses following the major trend. This occurs as prices begin to accelerate rapidly and there is news supporting the trend.
The final distribution phase occurs as the news highly favors the current trend and speculative volume and public participation increase even further. At this point, the well-informed investors who accumulated when the market was at its peak (trough) begin to sell (buy) before other investors begin to follow suit.
A Trend Is Assumed to Be in Effect Until It Gives Definite Signals That It Has Reversed
This is a major theory that essentially mirrors the physical law stating that an object in motion tends to continue in motion until some external force causes it to change direction. Relating that principle to price trends, a strong trend will tend to continue in its current direction unless there is a price reversal indication, as per technical or even fundamental analysis. The later articles will focus on learning to spot reversals in the market and how traders can place orders to take advantage of such reversals.