Introduction to Trends
Technical analysis is based on the assumption that prices follow a trend. Trend lines are hereby important for trend identification and confirmation. A trend line is a straight line that connects two or more price points and extends into the future to act as a line of support or resistance.
An uptrend line has a positive gradient and is formed by connecting two or more low points. Uptrend lines act as support and indicate that net demand is increasing even as the price rises. A rising price combined with increasing demand is very bullish, and shows strong determination on the part of buyers. As long as prices remain above the trend line, the uptrend is considered intact. A break below the uptrend line indicates that net demand has weakened and a change in trend could be imminent.
A downtrend line has a negative gradient and is formed by connecting two or more high price points. Downtrend lines act as resistance, and indicate that net supply is increasing even as the price declines. A declining price combined with increasing supply is very bearish, and shows strong resolve of sellers. As long as prices remain below the downtrend line, the downtrend is intact. A break above the downtrend line indicates that net supply is decreasing and that a change of trend could be imminent.
Again, it takes two or more points to draw a trend line. The more points used to draw the trend line, the more validity attached to the support or resistance level represented by the trend line. Even though trend lines are important to technical analysis, occasionally it is not always possible to draw trend lines on a given price chart. Sometimes the lows or highs do not match up. The general rule in technical analysis is: it takes two points to draw a trend line and a third to confirm its validity.
As the steepness of a trend line increases, the validity of the support or resistance level decreases. A steep trend line comes from either a sharp advance or decline of price over a short period of time. The angle of a trend line created from such a sharp move is unlikely to offer any meaningful interpretations. Even if the trend line is formed with three seemingly valid points, attempting to play a trend line break or to use the support and resistance level established will often prove difficult.
Sometimes there appears to be the possibility for drawing a trend line, but the exact points do not match up cleanly. The price highs or lows might be “off”, the angle might be too steep, or the points too close. If one or two points could be ignored, then a fitted trend line could be formed. With volatility present in the market, prices can over-react and produce spikes that distort highs and lows. One method for dealing with over-reactions is to draw internal trend lines, as an internal trend line ignores price spikes.
Trend lines can offer insight, but if used improperly may also produce false signals. Then again, other analyses can be employed to validate trend line breaks. While trend lines have become very popular again, they are merely one tool for establishing and confirming a trend. Trend lines should not be final, but should serve merely as a warning for changes in price trends. By using trend line breaks as warnings, investors can pay closer attention to other confirming signals.
Investment: Technical Analysis basics 5
Investment: Technical Analysis basics 4
Introduction to Trading ranges
Trading ranges are important in determining support and resistance as either turning points or continuation patterns. A trading range is a period when prices move within a relatively tight range. This signals that supply and demand are evenly balanced. When the price breaks out of the trading range, this signals that a winner has emerged here, where a break above is a victory for the “bulls” and a break below is a victory for the “bears”.
It is sometimes useful to create support and resistance zones. Each security has its own characteristics; analysis should reflect the securities’ intricacies. Sometimes exact support and resistance levels are best, and sometimes zones are better. Again, the tighter the range, the more exact the level. If the trading price range spans less than, say, 2 months and the price range is tight, more exact support and resistance levels are best. If a trading range spans months and the price range is relatively large, it is best to use support and resistance zones.
Identification of key support and resistance levels is essential to technical analysis. It is difficult to establish exact support and resistance levels. However, being aware of their existence and location enhances analysis and forecasting. If a security is approaching a support level, it comes to remind us to look for signs of increased buying pressure and a potential reversal of price. If a security is approaching a resistance level, it can tell us to look for signs of increased selling pressure and potential reversal of the price. If a support or resistance level is broken, the relationship between supply and demand has changed again. A resistance breakout signals that demand has won; conversely, a support break signals that supply has won.
Investment: Technical Analysis basics 3
Introduction to Support and Resistance
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Support and resistance are important parts of technical analysis, where supply and demand meet. Prices are driven by excessive supply and demand. Supply is synonymous with “bears” and selling. Demand is synonymous with “bulls” and buying. As demand increases, prices advance and as supply increases, prices decline. When supply and demand are equal, prices move sideways.
Support is the price level at which demand is strong enough to prevent the price from declining further. As the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches support, demand will overcome supply and prevent the price from falling below support.
Support does not always hold and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing to sell at even lower prices. Buyers cannot be coerced into buying until prices decline below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.
Support levels are usually below the current price, but it is not uncommon for a security to trade at or near support. In addition, price movements can be volatile and dip below support briefly. For this reason, some traders and investors establish support zones.
Resistance is the price level at which selling is strong enough to prevent the price from rising further. As the price advances towards resistance, sellers want to sell and buyers become disinclined to buy. By the time the price reaches resistance, supply will overcome demand and prevent the price from rising above resistance.
Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers cannot be forced into selling until prices rise above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.
Resistance levels are usually above the current price, but it is not uncommon for a security to trade at or near resistance. Also, price movements can be volatile and rise above resistance briefly; therefore, some traders establish resistance zones.
It is possible that support can turn into resistance and visa versa. Once the price breaks below a support level, the broken support can turn into resistance. The break of support signals that supply has overcome the demand. Therefore, if the price returns to this level, there is likely to be an increase in supply, and hence resistance. The other situation is resistance turning into support. As the price advances above resistance, the breakout above resistance proves that the demand has overwhelmed the forces of supply. If the price returns to this level, there is an increase in demand and support will be found.
