As a longer-term investor who bases decisions on fundamental valuations, there may be no need for you to dabble in the complex and highly-speculative world of “technical analysis.”
You may not need to understand the nuances of fibonacci variants, elliott wave calculations, or the 100+ indicators and oscillators that confuse with great accuracy but provide accuracy wrought with confusion.
But you might want to learn how to read a basic line chart. Why? If you are looking to buy, sell, or add to your current stock positions, it helps to have a context and reference point.
When you follow the market, you may be looking at the most current price, or percentage of daily or year-to-date gain. But what does that really tell you if you are looking to buy, sell, load up, or lighten your load?
For instance, as of today’s close, you check the SPDR S&P 500 ETF (SPY) and it reads as follows:
Well, that’s nice. Where is SPY in the larger scheme of things? Is it in an uptrend, downtrend, holding steady within a range?
If you’re looking to time your buys, should you purchase your entire allotment now, wait for a better price? If you are looking to sell or lighten your load, at what price might be a good level to consider selling some shares?
Introducing the Line Chart
This is a basic line chart. It strings together the closing price at the end of each day for the security it represents. In this case, we are looking at the SPY.
Today’s closing price is at the location to which the black arrow is currently pointing. Simple enough, yes? As you can see, price has been generally moving up since the beginning of March.
Does this indicate that price will continue to move up or that it might reverse and move down? No, it doesn’t. That’s where your fundamental smarts will have to come in.
After all, investing is a speculative activity. And all efficient markets are driven by fundamental factors and events. So stick to your fundamentals.
But which price levels might make for a “good” buy or sell? By asking this question, quite possibly what you really mean is at what price levels might a larger majority of investors jump in or get out.
Single price data might not help you here. Fundamentals might also not provide an accurate answer for this question.
But the line chart just might be helpful in ascertaining a probable buy or sell point if you know what you’re looking for.
Understanding Support and Resistance
Support is a price level from which a declining asset price might be expected to pause or reverse due to concentrated demand or scarcity of sellers. Think of it as a potential price floor supported by the actions buyers whose accumulated bidding causes prices to move upwards. When prices bounce off a support level, it indicates that there may be more buyers than sellers, more demand than supply, or larger purchases than sales.
Resistance is a price level from which a rising asset price might be expected to pause or reverse due to concentrated sales or lack of demand. Think of resistance as a virtual roof that deflects price toward the downside.
It’s important to note that support and resistance levels are never guaranteed to hold. Price can break below support or above resistance if there are fundamental factors respectively causing demand to drop or rise relative to supply.
But as historical support and resistance represents critical buying points (support) and selling points (resistance) for a large amount of market participants, there is a chance that these levels might hold in the future, making them slightly predictive.
Though it would be wise to exercise caution as any breach of supply may cause those holding “long” positions to dump their holdings en masse, causing prices to tumble further and faster below the supply level. Such actions may also be supported by short sellers who anticipate a rapid descent.
The same is true when prices break above resistance levels. This is particularly the case if larger traders holding short positions are caught in a “short squeeze,” in which case they are looking to close their “borrowed” positions by purchasing back the asset, sometimes in a panic.
Line, Support, and Resistance
Let’s recap everything we just learned. The lines on a line chart represent the movement of closing prices over time. Support indicates levels of concentrated buying while resistance indicates levels of concentrated selling.
Based on these indications and assumptions, support may indicate a favorable area for buying or adding to positions (as long as it holds). For the short seller, it is a potential profit target.
Resistance, on the other hand, indicates an area of potential price decline. Some investors might be interested in taking partial profits while longer-term investors will seek the ensuing support after the decline to dollar cost average. Short sellers may look to resistance as potential entry points.
In conclusion, we’ve just covered the basics of reading a line chart. Hopefully, you will be able to contextualize market action more clearly than just staring at the price and percentage loss or gain for the day.
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