The art of lines in Stock Market

A stock's price is the result of many differentfactors, but fundamentally it is determined by supply and demand like any othergood. Investors will buy when they think a stock is priced too low, and sellwhen they believe the price has hit a high point. By using support &resistance as well as moving averages we can understand how technical analysishelps us to trade in Future & Option market. The price levels similar tothese points are known in technical analysis as support and resistance lines.Support and resistance lines provide valuable clues about the possible futureprice movement of a stock.Most of the traders in themarket think of technical analysis as the unemotional application of lines,using past price movements to predict future ones. When we apply it to theprice of a stock, the interpretation is that the price of a stock goes up dueto increasing demand, and decreases because of increasing supply. When the twolines meet, the meeting point determines the current market price of the stock,and where the market reaches a (temporary) balance.

Support & Resistance:

Inthis paragraph, we will learn why support and resistance lines are developed.Generally, at support line it is expected that stock's price does not fallbelow, because at that price level there is sufficient demand for the stock tostop a downtrend. In other words, buyers for these stocks emerge as it reachesan attractive valuation level. Similarly, a resistance line is the level abovewhich usually a stock's price will not rise, because at that price level asufficient supply of stock is available to stop an uptrend. At this point, theowners of stock begin to sell and earn profit as it reaches a level where theybelieve it is fairly even or overvalued.

Horizontallines are drawn on a chart to indicate areas of support and resistance. The lowsfrom where the stock price has “bounced off” multiple times in the past areidentified as support. This price is where buying pressure overtakes sellingpressure, and the market moves higher. Resistance is the price on the chartwhere selling pressure overtakes buying pressure, and the market moves lower. Aresistance level is identified by a previous price high on the chart. Red linesin the chart below illustrate support (lower) and resistance (upper) lines.

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Noticethat, where the support and resistance lines are located changes over time.Support was initially at about 31.50 and resistance is at 42.50. The longerthat prices trade in a support or resistance area, along with how many"hits" it has taken, the more significant the area becomes.

Onceit is decisively broken, resistance levels can transform into support levelsand vice versa. Here’s a break through, a resistance line shows that the buyershave won out over sellers, and are determined to bid the price of the stockhigher than the previous highs. Once the resistance line is broken, anotherresistance line is created at a higher level. In that case, the previousresistance line often becomes the new support level. At this point, momentum ofthe stock to move in a single direction increases. More is the distance betweensupport and resistance lines, more favorable it is expected to be. The fartherapart the two lines are, the stronger each line is.

Thisis why technical analysis is used to consistently reduce your risks and improveyour profits. Thus, support and resistance levels are important tools for anytechnical analyst. Understanding whether a stock's price is near a support orresistance level allows you to be aware that a reversal may be likely. Supportand Resistance lines provide you a trading edge that will help you to improveyour odds of making profitable trades.

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Trend:

In technical analysis, concluding the trend of the stock is very important. A trend may be short term, long term or a medium term. The trend is always volatile. We can use moving averages to determine a trend. In a long term trend, there may be several short term trends. These trends may be a positive or a negative trend.

Youmust be in a dilemma as to which moving average to use, exponential or simple,10 or 20 moving average. Here is the answer; Simple moving average (SMA) is theaverage of recently closed price of the stocks for the past few days.Exponential moving average (EMA) is a weighted moving average that gives moreimportance to recent price data than the simple moving average does. Therefore,it’s better to use exponential than simple moving average.

Whenthe market moves sideways, a moving average won’t do you much good. You willfind that moving averages spend a lot of time just above or just below themarket, and you will see lot of crossovers. This could be a “whipsawed”. Onceyou close that trade (at a loss) and place another in the opposite direction,the market reverses again. In this situation, you would end up with lot ofloss. You need to recognize when the market is in a sideways trend and avoidtrading at that time.

Themoving average, which reduces the number of trades you need to make, but stillgets you in on all those big moves is the perfect time frame one should pick.To reduce the “whipsaw” problem, more than one moving average should be used.Try superimposing moving averages with two different time periods on a pricechart. When they cross is your signal to trade. In the below mentioned exampleI have used 20EMA & 200SMA.

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Noticethat where the 20 EMA & 200 SMA crosses over the stock consolidates for atime being and makes a new high. So, when there is a positive cross-over, thestock is bullish and when there is a negative cross-over, the stock is bearish.In this case 20 EMA was above 200 SMA, so it’s a positive cross-over and viceversa.

MovingAverages are a useful tool for understanding the overall direction of the stockmarket that are also best used in conjunction with other methods of analysis.They are a lagging indicator, so they will not get you out at the very top, norback in at the very bottom, but they do provide high quality trading signalsand are useful as confirming indicators.

Stay Tuned! Happy Investing!