Technical Analysis: Basic Concepts Every Trader Must Know – Part 2
A few weeks ago, I covered an important technical analysis concept every trader must know- trend lines.
In case you missed it, the value in recognizing trends lies in realizing the market’s overall direction.
Once you realize which way the market is trending, you can join that trend in search of profits. If the trend is up, you go long the market. If the trend is down, you can either short the market or sit on the sidelines until a bottoming pattern appears.
Of course, long-time readers know that when I’m talking about going long or short a commodity market, I’m referring to commodity based ETFs. Commodity ETFs offer a simple and efficient way to trade the hard assets markets without the complications and risks of futures contracts.
So let’s cover the next basic concept of technical analysis…
Support and Resistance
Technical support and resistance areas are important price zones where there’s high potential for a shift in market direction.
Let me show you an example…
Here’s a commodity I’ve talked a lot about recently- palladium. As you can see, this precious/ industrial metal has taken investors on a volatile and seemingly uncertain ride this year.
But notice the green and red lines in the chart and you’ll find palladium is trading between two distinct zones.
The green line at the bottom of the chart marks a zone of technical support between $660 and $640 an ounce.
By definition, technical support is a price area where buyers start outnumbering sellers. In other words, investment demand outpaces the available supply at important support zones. Such a situation can result in a change of market direction and higher prices.
On the other hand…
A resistance zone is where sellers start outnumbering buyers. Investment supply starts overwhelming demand at resistance zones. This ultimately sends the price of the commodity lower.
As you can see, palladium dropped heavily each time it ran higher into the $740 to $760 resistance zone this year.
How do you find support and resistance zones?
It’s relatively simple. All you do is find price areas where the market has consistently turned in the past. Connect those market tops and bottoms with a line (like I did in the chart above) and you’ll have an idea of where the market may shift in the future.
And what’s the benefit of finding support and resistance zones?
By identifying places where the market has high odds of changing direction, you can lower your investment risk and achieve higher profits.
Waiting to buy near major support zones gives you better chances of a trade becoming profitable quicker. In other words, you don’t have to sit in an asset and ride it down, waiting for the market to turn higher.
Buying at a support zone means the trade could be instantly profitable for you as other investors push the price higher.
And by finding the market’s resistance zones, you get an idea of how high the market will likely go. These resistance areas offer a great place to either short the market or sell a long position.
Bottom line…
The odds of the market turning higher at support, and lower at resistance, are better than when the market isn’t at one of these zones. That means the odds of your success are increased if you only buy and sell at these zones.
So there you have it…
Support and resistance zones are a basic technical analysis concept that every trader must know. Finding these areas can give you a leg up on the market by giving you a point of reference to establish and close your trades.
Until Next Time,
Justin Bennett
Category: Commodities, Technical Analysis
