Tag: technical analysis

Although many of you will find this lesson in one of the most basic concepts of market behavior "old hat", it never hurts to review. One of the first things a new trader is told (I hesitate to say learns as many never do) is to buy a breakout above resistance and sell a fall through support.

Resistance is the level which holds a market down, while support is an area which props up a market much like a ceiling and a floor. The key is to identify the critical levels. There are a number of methods to determine support and resistance: trendlines, moving averages, retracements, Gann angles, etc. However, simple observation can be an effective means of locating the important areas. A quick glance at the October cotton chart reveals the most basic levels of support and resistance (broken lines).

A previous high often provides resistance, while an earlier low tends to offer support. Support or resistance levels are not necessarily flat. For example, trendlines reveal areas of rising support or falling resistance. Also, when broken, uptrend lines offer a new level of rising resistance, while the opposite is true for downtrend lines. In fact, virtually any broken area of support will become resistance and vice versa. After breaking a level of support (or resistance), the market commonly comes back to test that level before resuming the downmove (upmove). This may be the single most effective method of locating low-risk entry points for trading purposes. This lesson may seem like wasted space to the experienced. However, it is amazing how often traders simply forget (or ignore) the power of basic support and resistance levels. This concept can be very profitable, but it may be just too "easy".

To some, technical analysis is a mystical method used by individuals to look into the future. Much of the glamour comes from the use of technical analysis as a predictive tool. While predictions can invigorate in a manner such as taking a joy ride, the end result will often feel like a ride gone bad. Although less exciting, the better use of technical tools can be likened to the tools a doctor uses to diagnose the condition of a patient. Similarly, a technical analyst applies his tools to determine the present condition of the market. Once a diagnosis has been made, a trader has a guide on how to approach a market. The understanding and application of tools is an important step in the development of an analyst or a trader. Properly used, various technical tools allow the drawing together of pieces of evidence to determine the market's present condition. While no one can guarantee the correct analysis of a market, the more evidence you gather, the better your odds. Once the evidence is gathered, diagnosing a market often ends up in a process much like jury deliberation. Each piece of evidence is considered; some will be accepted as valid, others may be suspect. Often one or two pieces of evidence prove to be the key in making a final determination. Once an analysis is made, based on the preponderance of evidence, a trader is ready to plan a course of action. TOOLS OF THE TRADE: The purpose of the series is to expose the reader to various analytical tools and to allow an insight into their applications. Hopefully the reader will have a better understanding of why a final diagnosis of a market's conditions has been reached.