Introduction
Technical analysis is built on
the assumption that prices trend. Trend Lines are an important tool in technical
analysis for both trend identification and confirmation. A trend line is a
straight line that connects two price points. If drawn further it acts as a line
of support or resistance. Many of the principles applicable to support and
resistance levels can be applied to trend lines as well. It is important that
you understand the concepts of Support and Resistance.
An uptrend line has a positive
slope and is formed by connecting two or more low points. The second low must be
higher than the first for the line to have a positive slope. Uptrend lines act
as support. A downtrend line has a negative slope and is formed by connecting
two or more high points. The second high must be lower than the first for the
line to have a negative slope. Downtrend lines act as resistance.
Conclusion
Trend lines can offer great
insight. While trend lines have become a very popular aspect of technical
analysis, they are merely one tool for establishing, analyzing, and confirming a
trend. Trend lines should not be the final arbiter, but should serve merely as a
warning that a change in trend may be imminent. By using trend line breaks for
warnings, investors and traders can pay closer attention to other confirming
signals for a potential change in trend.
Introduction
Fibonacci Retracements are
ratios used to identify potential reversal levels drawn from a top to a bottom
or vice versa.
These ratios are found in the
Fibonacci sequence. The most popular Fibonacci Retracements are 61.8% and 38.2%.
Note that 38.2% is often rounded to 38% and 61.8 is rounded to 62%. After an
advance, chartists apply Fibonacci ratios to define retracement levels and
forecast the extent of a correction or pullback. Fibonacci Retracements can also
be applied after a decline to forecast the length of a counter trend bounce.
These retracements can be combined with other indicators and price patterns to
create an overall strategy.
Retracement levels alert
traders or investors of a potential trend reversal, resistance area or support
area. Retracements are based on the prior move. A bounce is expected to retrace
a portion of the prior decline, while a correction is expected to retrace a
portion of the prior advance. Once a pullback starts, chartists can identify
specific Fibonacci retracement levels for monitoring. As the correction
approaches these retracements, chartists should become more alert for a
potential bullish reversal.
The inverse applies to a
bounce or corrective advance after a decline. Once a bounce begins, chartists
can identify specific Fibonacci retracement levels for monitoring. As the
correction approaches these retracements, chartists should become more alert for
a potential bearish reversal.
Conclusions
Fibonacci retracements are
often used to identify the end of a correction or a counter-trend bounce.
Corrections and counter-trend bounces often retrace a portion of the prior move.
While short 23.6% retracements do occur, the 38.2-61.8% covers the more
possibilities (with 50% in the middle). This zone may seem big, but it is just a
reversal alert zone. Other technical signals are needed to confirm a reversal.
Reversals can be confirmed with candlesticks, momentum indicators, volume or
chart patterns. In fact, the more confirming factors the more robust the signal.
Introduction
Support and resistance
represent key junctures where the forces of supply and demand meet. In the
financial markets, prices are driven by excessive supply (down) and demand (up).
Supply is synonymous with bearish, bears and selling. Demand is synonymous with
bullish, bulls and buying. These terms are used interchangeably throughout this
and other articles. As demand increases, prices advance and as supply increases,
prices decline. When supply and demand are equal, prices move sideways as bulls
and bears slug it out for control.
Support is the price level at
which demand is thought to be strong enough to prevent the price from declining
further. The logic dictates that 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 the support level, it is believed that
demand will overcome supply and prevent the price from falling below support.
Resistance is the price level
at which selling is thought to be strong enough to prevent the price from rising
further. The logic dictates that as the price advances towards resistance,
sellers become more inclined to sell and buyers become less inclined to buy. By
the time the price reaches the resistance level, it is believed that supply will
overcome demand and prevent the price from rising above resistance.
A price 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. 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 sell at
even lower prices.
Another principle of technical
analysis stipulates that support can turn into resistance and vice versa. Once
the price breaks below a support level, the broken support level can turn into
resistance. The break of support signals that the forces of supply have overcome
the forces of demand. Therefore, if the price returns to this level, there is
likely to be an increase in supply, and hence resistance.
The other turn of the coin is
resistance turning into support. As the price advances above resistance, it
signals changes in supply and demand. The breakout above resistance proves that
the forces of demand have overwhelmed the forces of supply. If the price returns
to this level, there is likely to be an increase in demand and support will be
found.
Trading ranges can play an
important role in determining support and resistance as turning points or as
continuation patterns. A trading range is a period of time when prices move
within a relatively tight range. This signals that the forces of supply and
demand are evenly balanced. When the price breaks out of the trading range,
above or below, it signals that a winner has emerged. A break above is a victory
for the bulls (demand) and a break below is a victory for the bears (supply).
Conclusion
Identification of key support
and resistance levels is an essential ingredient to successful technical
analysis. Even though it is sometimes difficult to establish exact support and
resistance levels, being aware of their existence and location can greatly
enhance analysis and forecasting abilities. If a security is approaching an
important support level, it can serve as an alert to be extra vigilant in
looking for signs of increased buying pressure and a potential reversal. If a
security is approaching a resistance level, it can act as an alert to look for
signs of increased selling pressure and potential reversal. If a support or
resistance level is broken, it signals that the relationship between supply and
demand has changed. A resistance breakout signals that demand (bulls) has gained
the upper hand and a support break signals that supply (bears) has won the
battle.