Through the course of the past three months, we brought to you a series of articles every monday on Trading Strategies that work well in the Indian Stock Market.
Continuing the series of articles every week, we bring to you certain aspects associated with Technical Analysis and an indepth study of the same.
What is Technical Analysis?
To begin with, Technical Analysis is a simple theory, if not complicated by unnecessary add-on measures.
Unlike Fundamental Analysis, Technical analysis does not take into account an organization’s value but focuses on the movement of its price as a result of supply and demand.
In the stock market, supply and demand is highly influenced by emotions of fear and greed and traders hope to work both to their advantage.
Most market analysts, like Meir Barak believe Technical analysis is nothing more than a reflection of human psychology as seen in market directions.
Technical analysis is fundamentally based on the concept of “history repeating itself”.
Technical Analysts believe studying past market data always provides an insight into how the future stocks would move.
Trends are one of the most important concepts associated with Technical analysis.
Let’s begin by looking at the definition of what a trend is.
A trend is basically the general direction in which a market is headed.
Prices do not tend to follow straight lines in any one direction but appear in chains of lows and highs.
In technical analysis, the movement of these lows and highs is what defines a trend.
For instance, upward trends are categorized as a series of higher highs as well as higher lows while a downward trend (downtrend) is about lower lows and lower highs.
If you want to get more technical, the horizontal sideways trend is not a really trend but a lack of a definite trend in either directions.
For more information on Trends and the use of trends in Technical analysis :Click at http://stockmarketsignals.com/technical-analysis-fundamentals-use-trends/
Through the course of this article, we’ll be looking at the Importance of Support and Resistance in Technical Analysis.
Support and Resistance
Technical Analysts often refer to “lines of support and resistance” in their attempt to study and analyze the market directions.
By definition, Support is a price level where “greedy” buyers enter the market to prevent prices from declining further.
Support can develop at a specific price or in a price zone.
The space for support can be held for many months at a time.
Volume by Price is another force that comes to play in case of support.
Similarly, by definition, Resistance is a price level where “fearful” sellers suddenly come into the market and prevent prices from advancing further.
It can be considered as the exact opposite of Support.
Resistance can develop at a specific price or in a price zone.
The space for resistance can be held for many months at a time.
Further study has proved that support and resistance could be found at high & low points, in moving averages and in round numbers.
Areas of Support and Resistance
Towards the earlier part of the 20th century, several traders had begun trusting the logic that a stock must break out from or break down “even the smallest resistance” to be traded.
Traders back then did not have access to charts and other tools like we do now – therefore, they traded only through the use of support and resistance.
Through the power of memory, they would jot down the highs and lows to relate them to future support and resistance.
It is believed that even traders from NYSE (New York Stock Exchange) did not have access to charts or trading tools.
This further proved how important identifying areas of support and resistance in a stock is while trying to analyze the trend to know more about the entry as well as exit points.
When Support and Resistance Exchange Their Places
When can we say that Support has turned into Resistance or Resistance has turned into Support?
This is one of the most crucial difficulties faced by chartists all over the world.
The inability to realize is mostly due to the thin line of differentiation that we, as traders, often miss.
So, keep an eye out for either of these two market situations :-
- When an area of resistance breaks out and turns into an area of support.
- When an area of support breaks down and turns into an area of resistance.
Let us begin by looking at possible situations which contribute to such a reverse in role :-
1. Resistance Becomes Support – Why?
Traders prefer buying stocks that break out through resistance because when a stock breaks out, they buy it thinking the price might go higher.
Mostly when the price goes higher, they wish to buy more of the same stock – thus making the stock far more expensive.
Finally, traders wish to increase the amount of stock they hold if the stock price falls to its breakout figure and when this happens, their buying establishes support.
Would be when other traders miss out on the breakout seeing the stock price rising but these traders don’t buy the stock at its peak and wait till it falls back to the breakout price.
Buying when the stock returns to the breakout price indicates traders support the price and establish support.
The last situation could be because of traders who are “short sellers” and are on the support list hoping that the stock prices won’t rise.
Seeing that they have missed out on the opportunity before the breakout, they lose money.
Finally, when the price of the stock drops, they buy and finally establish support.
2. Support Becomes Resistance – Why?
Traders prefer selling short stocks which break down through support.
In cases where a stock is seen to break down through support they either sell the stock hoping the price will go down (if this happens, the stock might hit a new low) OR they regret not selling the stock but hope to increase the amount of their sell if the price returns to the breakdown point.
Finally, if the price returns, traders could increase the quantity of their sale and create more resistance.
Traders who have missed out on the breakdown find that the stock price is dropping and regret not making the sell.
They dont sell when the price is at the lowest but wait till the price returns to its breakdown point.
If the price of the stock goes up again, they will sell and create resistance.
Traders who engage in “long trades” are those who bought the stock much before its breakdown believing that the price would go up.
These traders are often known as “long traders” are usually, in such situations, caught making a loss.
Having sustained such huge losses, they wish for the price of the stock to go up to its breakdown point so that they can sell.
When this happens, they also sell to establish resistance.
Therefore, we see how much before the invention of charts and trading tools, analyzing support and resistance were the only means for traders aroung the world to map the movements of the stock market.
Today, Support and Resistance is measured and mapped by hundreds of trading tools and indicators – making this an easier factor to access.
Nevertheless, it remains one of the pivotal factors which govern the method of trading through the use of Technical Analysis.
To know more on Technical Analysis, read our free report here: http://stockmarketsignals.com/Fundamentals-of-Technical-Analysis