Trading Elementary School Lesson 1 – Full Lesson List:
Welcome to Elementary School students. You have come far. Well done.
The first concept we are going to introduce you to is that of support and resistance. It is one of the more basic ‘advanced’ concepts in trading and pattern analysis. In principle it is fairly easy to grasp.
The below graph shows a bull market. Bull markets never go up in a straight line. As the price line heads up, then pulls back, and head ups and pulls back, it forms a type of zig zag. The high point it touches, before pulling back, represents the resistance point.
And, on the flip side, the lower point it pulls back to is now its ‘support’ level.
The opposite is the case in a bear market, with a price line trending downward.
As you’ll know from previous lessons, there is a lot more information to be found in candle-stick charts. They are preferred for good, active traders.
With candlestick graphs you will often see what appears to be a break in support/resistance. When actually these levels are really only being tested.
The shadows will pass through the support/resistance level. But they end up closing at a point that maintains the previous level. You can see that occur a few times at the support level, on the graph below.
There is no exact answer to this question.
Let’s take our same example from above and see what happened when the price actually closed past the 1.4700 support level.
If we take a look at the chart below, as an example. Support looked like it was broken. But, with the benefit of hindsight, we can see this way only a ‘false breakout’. The price continued on, much stronger.
This is where line charts actually come in handy, to help you filter out these ‘false breakout’ situations. Line charts, by design, only show the closing price. They remove the extreme highs and lows that are included in the candlestick charts.
On the line chart it is best to plot support / resistance levels where the price is forming several peaks/valleys.
A price that passes through resistance, could see that resistance then become support.
The more a resistance / support level is tested, without breaking through, the stronger that area of resistance / support.
When a support / resistance level is broken, the strength of the follow-through really depends on how strong the broken support or resistance had been holding.
Trend lines are a standard form of technical analysis.
When used correctly they are very accurate and useful. The key is to make the market fit the line, and not vice-versa.
To create good, correct and proper trend lines on a graph, simply identify two major tops / bottoms, then connect both. It really is that simple.
From the above graph you will notice three main types of trends; an uptrend, downtrend and a sideways trend.
It is important to note that, a minimum of two tops / bottoms is required to draw a trend line. However, it will take three tops / bottoms to confirm it.
Further a steeper trend line is less reliable and more likely to break. And a trend line becomes stronger the more it is tested.
The most important point when drawing trend lines is don’t ever try and force them to fit into the market. If it doesn’t fit then it ain’t right.
Channels are another weapon in your technical analysis arsenal, allowing further insight as to timing for buy / sell orders. After all, as a trader, that is what all this analysis is about. You want to know when to buy and when to sell.
The top / bottom of a channel indicates to traders the potential support / resistance levels.
This is done at the same time as creating the trend line. For an ‘Up Channel’, you will proceed to draw a parallel line to the uptrend line. You will then move the line, so that it touches the nearest peak. For a ‘down channel’, the inverse is true.
Prices that hit a bottom trend line represent a potential buying region. And for prices that hit an upper trend line, you would have a potential selling area.
What use is understanding the basic principles of support and resistance if you can’t use this knowledge. We should never forget that the idea here is not knowledge for its own sake. We’re trying to become better traders. The end goal is to make money.
When trading support and resistance there is ‘The Bounce’ and there is ‘The Break’. That’s all you need to know really.
The idea of trading the bounce is to get the odds of success in your favour, as much as possible. We are also looking for confirmation it is not a false break, and that the support / resistance is going to stick.
So, rather than simply buying or selling right on the actual line, you wait for the price to ‘bounce’ before going into the market with your order. In this way you have a better chance of avoiding those fast moving prices which break right through support / resistance levels.
In the real world support / resistance levels often break. Playing bounces is fine. But that’s not enough. We need to also know what to do when these levels break.
There are 2 alternative strategies for trading a break; aggressive and conservative.
Aggressive is the simplest way to trade breaks.
This involves buying / selling when the price passed ‘convincingly’ through a support / resistance area. Obviously the word convincingly is a little ambiguous, intuitive and non-mathematical.
Essentially we are looking for support / resistance area to look like it has been smashed with a hammer. You will have to use your gut and instinct on that.
That’s aggressive trading. Conservative trading involves a little more soul searching. Here is where your character gets truly tested.
When you find yourself in a losing position do you simply accept defeat and exit your position? Or do you wait and hope to regain the loss on a later move?
This type of trading revolves around the second choice.
Bitcoin and altcoin trading is a type of forex trading. You have pairs. So when you close a ZAR/BTC long trade at the break even point, this means that you will be shorting the ZAR/BTC by an equal amount.
When there is enough people selling losing positions at this broken support level, the price will reverse and start falling once more.
This is why support levels that are broken so often become resistance levels.
Patience is key here. You should not enter immediately on the break. Rather, wait for the price to pull back to broken support / resistance. Then you should enter after the price bounce.
You should be aware that this is not going to work all the time. It’s important to know that. The price often will simply move in one direction. You will then be left behind. Stop losses are an important mechanism to avoid catastrophic losses.
Also, hope is a killer. Don’t hold onto a trade because of hope.
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