Trading on the stock market is all about spotting the moment when the market is about to move and making the most of it. There are a number of tools available to any trader that will help them do this and most deal with the concepts of support and resistance.
Most of the time, we prefer to trade with the trend, whether it is going up or down. A trend following strategy is usually the least risky. Estimates vary, but most financial securities trend up or down only half the time. The rest of the time the prices are going sideways, fluctuating up and down in a limited range. For that situation, you can adopt a CFD trading strategy which uses the apparent limits of the support and resistance levels.
The support level is the price which the security doesn’t seem to want to go below, and resistance level is the price that is not being exceeded. Support and resistance are dictated by simple rules of supply and demand. If the market is a seller’s market, the price will drop to such a level where some sellers no longer want to sell because the profit is not great enough and other traders will look to buy because the price has become low enough that it is considered to be a good price. These two factors together will start to push the price back up, and the bottom of the dip is considered the support point.
Of course, one point on its own is not very easy to trade with, so traders wait for the market to return to that level. When the market bounces again having approaching this support level, traders can determine that it is a level of support. Having tried twice to sell the price down and failed, buyers then tend to take the upper hand and the price moves away from the support price. The same applies with resistance. If buyers have the upper hand, the price rises, but it reaches a level where it is no longer considered a good deal to buy, and so the market recedes from that level. Having dipped back down, buyers have another attempt but fail to breach the previous level. After this it is apparent that the market cannot climb anymore, so people with those shares sell theirs to make a profit and the market falls away.
Support and Resistance Levels Trading Strategies
Stock prices can bounce between the support and resistance levels for a long time before they breakout to set new limits. If the support and resistance levels are clear, and you feel confident locating them, you can trade to ride between the levels, alternately going long and short. These are fairly short and frequent trades. The advantage is that you have a trading strategy that does not depend on waiting for a trend to emerge.
First, you should check whether the overall market is going sideways. You can determine this visually, by looking at the chart, or by using a suitable indicator. You need to repeat this check on the stock’s sector and on the stock itself. You should look at longer time scales so that you can be sure that any previous trend has finished, and that the prices are going sideways.
The other prerequisite for this CFD trading system is that the support and resistance levels are clear, and are confirmed by several price visits to the same levels from which the price recoiled. The more times the price has visited the level and turned back, the more sure you can be of the validity and strength of the support and resistance.
The trade is made when the price approaches the support or resistance. If the price is coming down to support, then you would buy a long CFD position in the stock. If the price is going up towards resistance, then you want a short position. Either way, you are expecting the price to come back from the limits of its range.
As soon as you place your trade, you need to have a stop loss order just outside the support or resistance level. That is, just below the support if you are long and anticipating increasing prices, and just above resistance if you have gone short in the expectation that the price will fall. Either way, if the stock breaks out instead of trading in the range, you will be stopped out of the position and minimize your losses.
To exit the trade, you can use a simple trailing stop, placed with regard to the normal fluctuations of the stock. An alternative is to look at the previous week’s range of prices, and use these as a guide for a trailing stop. If the price approaches the opposite line, you may choose to manually exit the trade when it is close. This is just a very simple guide to support and resistance but learning the fundamentals is important. Any form of trading whether it be CFDs or through directly buying and selling on the market relies on support and resistance.