Getting Started With Technical Analysis – Support and Resistance
is one of the forecasting methods to assist traders in making better trading decisions. It is the study of how market prices behave to gain profits.
The objective of technical analysis is to forecast the price over a period of time in the future and then to use this information to decide whether to buy or sell your futures contracts. Traders who use technical analysis are into a very opportunistic style of trading as compared to holding on the assets or long-term investing.
The general perception is that technical analysis is all about charts, graphs and lines. While this may be true to a certain extent, technical analysis is more than that. This method of forecasting prices is also a way of managing market risk.
At the end of the day, you want to take advantage of any methods or tools that can help you to achieve your goal, which is to make profits.
The Charts
In technical analysis, price and trends rule. You must be familiar with reading prices, trends and price charts.
The image below shows a typical chart that you’ll see in charting software or trading programs. The chart is the workspace of technical analysis. Based on the charts, there are numerous theories and indicators that have been developed over the decades such as the Gann, Fibonacci and Elliot Wave.
As someone who starting out in technical analysis, your role is to identifykey reversal trends as early as possible.
Key reversal trends are trends that tend to go in an opposite direction. For example, an upward trend reversing means it will go on a downward trend. Likewise a downward trend reversing means that it will go on an upward trend.
Support and Resistance
Support and resistance is a concept in technical analysis whereby the price movement will stop and reverse its trend.
In technical analysis, it is important to identify the support and resistance lines to gauge where the prices may reverse as well as to gauge the limits of a trend.
The more times the prices bounce off either the support or resistance lines, the stronger the support or resistance levels become.
These trends have been repeated throughout history patterns. The image below shows a historical chart of the S&P 500 Index from 1928 to 2008. You can observe the strong support and resistance lines.
Breakout
Whenever a line breaks the resistance line, it’s called a breakout. As a result, the price will keep going on an upward trend and it will take some time to find a new resistance or ceiling level.
Fallout
Fallout is the opposite of breakout. This phenomenon can also happen on the downside. Once the price goes below a support line, it will keep going on a downward trend and it will take some time to find a new support level.
Support and resistance lines are important in identifying key reversal trends. In the next article, we will look into another concept in technical analysis known as Retracements and Trend Reversal.
Getting Started With Technical Analysis – Understanding Retracements and Trend Reversal
As pointed out in the previous article titled Getting Started With Technical
Analysis – Support and Resistance, it is important for traders who rely on technical analysis to identify key reversal trends.
The second part of this article will touch on the importance of retracements. Retracements are temporary price reversals that take place within a stronger trend.
Some traders and investors also refer to them as correction.
In using technical analysis, it is critical to identify whether the trend is undergoing a retracement or a complete reversal.
There are many theories and methods to identify different types of retracements such as the Gann, Fibonacci, Elliot Wave and more.
One of the basic principles of retracements is that it does not challenge the trend.
For example, referring to the illustration above; the second retracement does not challenge the lowest point of the first retracement. The third retracement does not challenge the lowest point of the second retracement. All in all, it is always an upward trend.
The 50 Percent Gann Retracement
There was a man named WD Gann in the early 1900s who noticed the securities that he was trading to have retracements at 50 percent.
For example, if the price is $10 and has moved up to $30, the retracement will normally happen at 50% which will be at $20. You can get this by taking the price movement difference ($30-$10) = $20 and then divide by 50% which is $10. Thus the retracement is by $10 from $30 which is at the $20 level.
This will be a signal to buy because the trend will still be going up.
There are also other indicators following the Gann 50 Percent theory. Such examples are Fibonacci Fan and Elliot Wave Principles of which the analysts who came up with these theories were believed to be influenced by Gann’s theory.
Studies have shown that many retracements are not the exact 50% but ranging from 45% to 55%. It still serves as a good guideline to traders today.
Fibonacci Retracements
Another theory about the pattern of retracements is based on a sequence of numbers. The sequence of numbers was developed from an Italian mathematician named Fibonacci. Hence the retracement theory derived from these sequences of numbers is that there will be certain percentage of retracements before a trend reversal.
The Fibonacci retracements will occur at three levels. They are 32%, 50% and 61.8%. Below is a graphic example explaining the pattern.
Once there are retracements of these percentage levels at 38.2%, 50% and 61.8% in a single trend, it is an indicator for a trend reversal.
Elliot Wave Principle
The basic idea behind the Elliot Wave Principle is that price trends have two sections, the impulse wave and a correction wave.
Each impulse wave has five parts: three waves that go in the trend direction and with two that go in the opposite direction.
Impulse Wave
Once there is an impulse wave, the trend will reverse to a corrective wave.
The Basic Elliot Wave Principle
This pattern will keep emerging on the price chart throughout the price trend. The Elliot Wave Principle also dictates that whenever the impulse wave hit a new high in a bull market, it is a highly likely indicator for a trend reversal to a bearish market.
Other Indicators in Technical Analysis:
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