Most investors are mystified by price changes in the financial markets. Fortunately, the trends are really simple to follow when you understand what drives them. Stocks and other assets can look very appealing when they drop to a specific price. A larger number of investors purchase them, which drives the price higher. As the price increases, demand for them declines and many investors start to sell their holdings. This drives the price lower again, until demand becomes strong enough to force the price higher.
You can increase your profits by identifying the price patterns that develop from changes in supply and demand. Savvy investors use support and resistance tactics to predict future price movements for stocks and other financial assets. Here are some things that you will want to discuss with a financial advisor such as Aaron A Delsignore if you are planning your investing plan.
What is Support and Resistance?
Many stocks trade within specific price ranges. A recent study from the Federal Reserve Band of New York found that prices of currencies tended to bounce off published support and resistance levels over 60% of the time (these are known as sideway market), which they said seems to hold true for other markets. We can improve our trading strategies by identifying the support levels (the price that the stock rarely falls below) and resistance levels (the price the stock rarely rises above).
Timing is very important in sideways markets. You should ask your broker to automatically buy, sell and short securities when the prices reach the support and resistance level so that you don’t miss your window of opportunity. You can do this by placing market orders. Market orders are very easy to setup and your broker will be happy to provide more information if needed. However, you’ll want to make sure that you cancel those market orders if it looks like the security will break from the trading range.
Here are some tactics that you’ll want to try after you identify support and resistance levels.
Open Long Positions at the Support Level
The price of the security will probably change directions when it touches either the resistance or support levels. Try these tips when you see the price moving near either limit:
- Purchase the security when it nears the support level. The security will probably start to increase in value shortly, which means that it will be a good time to open a long position.
- Sell or short the security when it nears the resistance level. The security will probably start to decrease in price shortly.
You should pay close attention to the resistance and support levels. Prices can move very quickly in a volatile market, so you may want to consider asking your broker to setup a market order to automatically buy or sell the security near these levels.
Open Short Positions at the Resistance Level
You can use the same strategy to short the security. You are simply doing the reverse of the same strategy outlined above. It is pretty simply if you understand short selling. If not, we suggest you take a quick look at our article on short-selling.
You’ll announce a short position when the stock nears the resistance level. You can ask your broker to use a stop-loss order to automatically close the short position when the price drops to the support level.
Open Long and Short Positions
Both of these tactics are very effective strategies. You can boost your returns even more by executing them concurrently. Here is what you’ll need to do:
- Purchase the security at the support level.
- Sell the security when the price rises to the resistance level and open a short position.
- Close the short position when the price drops to the support level and purchase a new security.
You can nearly double your returns by executing both orders together. However, you’ll want to make sure that you are sure about the market price range first though. You don’t want to short a security that is going to increase significantly in value. You’ll also want to use market orders, because there is often such a small window of opportunity to execute these trades.