Posts Tagged ‘Technical’

Trading Basics, Part I – Support & Resistance

September 4th, 2012 No comments

Critics of technical analysis is sometimes liken it to reading tea leaves, perhaps because it is partly subjective. There are a lot of different tools, but most traders pick and choose only a few to use. But the same could be said about running a business, and yet we can clearly see some individuals have consistently better track records than others for being profitable. The analogy is especially appropriate because successful traders tend to view trading as a business.

The most basic technical indicators are support and resistance levels. Support are relatively low price levels the stock has trouble falling below, and resistance is the relatively high price level the stock has trouble climbing above. If a stock is “range-bound”, trading within a tight price range, the high end of that range is the resistance and the low end is support. Other key price levels are where spikes or dips occur. It’s rare that these key levels are hit precisely, down to the penny, so some eye-balling is required, and some practice is required to select the most effective levels. The best price levels tend to be at round numbers.

Notice how often and spikes and dips turn around close to multiples of 1000 points.


When a stock price breaks out above a key resistance level, resistance often becomes support. And likewise when support is broken, it becomes resistance for the stock price thereafter. Moreover, when a stock price breaks through a support or resistance level, the stock price usually continues in that direction and changes at a faster rate. These technical moves provide an opportunity for traders to make quick profits.

From an Austrian perspective, there are real human action reasons why it works this way. The most common reason articulated is that of the “bag-holder”. This is someone who bought the stock at a higher price and held onto it despite it having gone down. When the stock moves to the top of its trading range, the bag-holder sees an opportunity to finally get out at a decent price. Another common reason has to do with belief. Traders may not believe the stock likely to break out above resistance, so when the price gets there, they take a short-position, betting on the stock price dropping. Speculators may also be trading within the range, buying at the low of the range and selling at the high.

For these various reasons, as the price reaches the resistance level, it brings in a disproportionate number of sellers, which of course will tend to push the price back down. However, if enough buyers take interest in a potential breakout, there are buyers for all the sellers. Once all the sellers have sold, the buyers push the stock price into a zone where there are relatively few sellers, and this allows the stock price to rise very quickly. This works for individual stocks as well as the overall market and creates difficulty for mathematical economic and financial models because breakouts stack the odds to make outliers more common than stochastic movements can account for.


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