Understand how the market moves, and you increase your odds of success.
In theory, markets are pushed higher and lower by fear and greed -- two of the strongest psychological drivers of all assets.
For example, many times you’ll hear technical analysts refer to the ongoing tug of war between bulls and bears, or the struggle between buyers, which represent demand, and sellers, which represent supply. When looking at fear and greed on a chart, we begin to look at the technical parameters of support and resistance, or a price floor or ceiling.
When prices are falling, support represents the moment when buying begins to overwhelm selling and prices begin to bounce back.
Conversely, when prices move to the ceiling, resistance is the point where selling begins to overwhelm buying and price increases begin to reverse.
You can identify support and resistance by studying charts.
With support, you want to look for a series of low points where a stock ceases to fall any more. Then, when you find a stock that rises to a certain high, but rises no more, you have found resistance points. Better yet, the more times a stock bounce off support and resistance, the stronger these support and resistance lines become for technical analysis.
If your stocks bounces off the same support level, or fails at the same resistance level at multiple times, we can make an argument for selling or buying said asset at those points.
Look at Royal Caribbean (RCL) for example.
After getting beaten up by Hurricane Irma fears, you’ll notice that prior support levels at $116.65 held since early August 2017. Had the stock fallen below that triple bottom support levels, an argument could have been made for further downside in the name. At the same time, we can also use the 50-day moving average as our support line, as well. As you can see in the chart, the 50-day has held as support since October 2016. Each time the same area of support held, the bullish argument at those points strengthened.
Or, we can look at shares of Apple (AAPL).
Between May and June 2017, as hard as the stock struggled to break above $154.76, it couldn’t. Twice at that point the sellers overwhelmed buyers, eventually sending the stock to test prior support around $142 a share.
Of course, it’s important to always confirm areas of support and resistance with other key technical tools, such as the Bollinger Bands, MACD, relative strength (RSI), Money Flow (MFI) and Williams’ %R for example. Never rely on just one argument. Doing so sets traders up for potential failure.