Adding a 3rd Skill to Our Trading Arsenal
In the last few days, we’ve covered the trading terms “resistance” and “support.”
By way of review:
- Resistance is a particular price level that stocks struggle to break above. From a supply and demand perspective, resistance represents a level at which buying demand struggles to overcome selling pressure. As a result, this level acts as “resistance” to a rally.
- Support represents a line at which stocks refuse to break lower. From a supply and demand perspective, support is where buyers come into the market to absorb selling pressure. This is what stops the markets from breaking down further.
Our timing on these topics could not have been better. The market showed us the significance of both resistance (red line below) and support (green line) several times this week.
Just look at how the market was rejected at resistance before dropping to bounce off support!
Now that we’ve covered resistance and support, I want to introduce you to a new concept: trendlines.
Searching for a Bullish Breakout
While resistance and support are represented by horizontal lines, trendlines are typically diagonal, formed by a series of moves that end at lower or higher levels.
Let’s use a real-world example to see this in action.
The chart below shows the recent price action in gold. As you can see, we have a clear level of support at $1,680 (green line). Note how gold bounced hard off of this level multiple times.
However, you’ll also note that gold was also forming a series of lower highs – price points at which the precious metal reversed downward after rallying. Note too that this series of lower highs resulted in a clear downward sloping line (blue line). THAT is a trendline.
As you can see in the above chart, gold recently broke out above this downward trendline.
This is VERY bullish, as it shows gold now has enough buying power to break above a clearly defined trend. This is what traders refer to as a “bullish breakout.” It usually signals that the asset is ready to make its next major move higher.
Now let’s add resistance (red lines) to this chart. Because gold has been trading in a relatively tight range over the last two months, we’ve got three of them.
Yesterday’s breakout saw gold breaking above the first and attempting to break above the second before ending the day just below it. If gold can break above this second line, we should see a move to test its third line at $1,730 (top red line). That would be my first target if I was trading this chart.
And if gold can break above that final top line of resistance, it will begin a major bull run.
To review, we now we have three trading tools in our tool belt:
- And trendlines.
Armed with these three tools alone, a chaotic chart can suddenly make a great deal of sense. And even better, it can provide you with a trading plan with defined targets.
Editor, Money & Crisis