When I had a talk at the University of Santo Tomas to several finance students last week, one of them asked me on what is the easiest strategy to trade the financial market. I knew for sure that it was everybody’s question in the room. It might also be your question, the very reason why you are reading this blog today.
True enough, we don’t like complicated things, all we want is to learn it to the very basic. With all the jargon and out-of-the world terminologies, like them, we are thinking that there must be simpler ways.
What if I tell you that in trading we only need an elementary mathematics and a simple analytical skill? I can’t think of anything else other than my good buddies, “support and resistance”. They’ve been with me on my journey in trading for the longest time, through ups and downs.
If you would only learn one thing in life, this trading strategy is already enough and doable. As a matter of fact, stock market is really not a rocket-science. You can be successful by just applying this.
It’s the most basic concept in technical analysis but it is very helpful that all of the traders around the world are using it. To ignore them, it only means you’re putting yourself in a big trouble.
As we can see above, support are the previous low price of the stock while resistance are the previous high price. This is highly-used in trading because support serves as the floor of the stock where buying is high and resistance serves as ceiling of the stock where selling is high.
As a rule of the thumb, the best buying opportunity is when the stock is near the support area because you can buy it a a lower price and most likely the stock will go up. The best selling opportunity is when the stock is near the resistance because it is already considered expensive and possible for a profit taking.
Looking at the daily chart of PSEI, resistance area is around 8,600 points while support area is around 8100. When you have a defined support and resistance, you would be more at ease in making your decision on when to buy and when to sell. You will also see the big picture on what is happening. Trading is now much easier.
If you want to get more some trading strategies, you can learn William J. O’neil’s system on this blog How to make money in stocks: Follow these 7 simple steps.
Good thing about technology and automation, you will just click it and it will plot support and resistance for you. How does it sound? Amazing, right?
Once these important lines are drawn, you can already set your buying and target price. This is a great way to locate your entry and exit. Moreover, once you get the experience in trading, spotting them is very easy without the need of putting some lines.
The more times support and resistance are tested, the more it becomes valid. As we can observe, resistance are tested four times while support are tested three times.
When a stock is not successful in breaking the resistance line, meaning sellers are stronger than buyers. When a stock is not breaking the support, buying demand is very high.
When buying demand is stronger than selling, breakout happens at the resistance area. Many traders are considering it as a good buying signal. We call it a “breakout” and it has to be confirmed with a good volume. If it is not supported with a relative volume, breakout might not sustainable.
When selling demand is stronger than buying, breakdown happens on the support area. Many traders are spotting it as a warning sign. It has to be confirmed with a high volume to prove that there is a strong selling. If it is not supported with a volume, a decline is just a false alarm. It may soon bounce back.
Role Reversal Between Support and Resistance
When a previous resistance is broken, it will now become its new support and when a previous support is broken, it becomes its resistance area. This is what we call “role reversal”.
It is very significant because when support becomes resistance, it might signal that the uptrend has already ended and the new downtrend is about to start. Same thing applies to the resistance.
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