If you are seeking thrill from the stock market, you do not care about the fundamentals of the company, you are solely focused on price action, or you like analyzing chart patterns, then technical trading might be for you. How do technical traders think? What specifically do they focus on? In this blog post, we will address these two questions.
First off, what is the formal definition of a technical trader? According to Investopedia, a technical trader is someone who looks back in history, using the recognizable patterns of past trading data, to predict what might happen to stocks in the future. While trading, a technical trader might look at various indicators and have different strategies, but all technical traders always focus on two things : support and resistance. Support is simply the lowest price that the stock has traded during a given time frame, and resistance is the highest price that the stock has traded during a given time frame. Let me illustrate this with an example. In the 1 day time frame for Pfizer Inc. (below), we can see the green horizontal line (support) at $43.50, and the red horizontal line (resistance) at $44.53. Another way to look at support and resistance is by visualizing that support line prevents the price from falling lower, and the resistance line prevents the price from going higher.
As you can see from the graph above, every time the price approached the $44.53 red resistance line, the price got rejected and dropped lower. Similarly, every time price approached the $43.50 green support line, the price got rejected and bounced back up. So, the price always stays between support and resistance. Since all technical traders are closely monitoring the support and resistance levels, every time price reaches the green support line, traders would execute buy orders. On the other hand, when price reaches the red resistance line, traders would execute sell orders. Since all traders are thinking and acting in a certain way i.e. buying and selling at specific levels, you can say that they are moving the market to their advantage. By closely monitoring the support and resistance of a stock, you can predict when the stock might bounce up/down.
So, how do technical traders think? They think like the crowd. If you notice resistance at $44.53 (example above), you can tell yourself that everyone is looking at that level as well. After that, you can set trigger trades as price approaches that level. Since price moves in accordance to the support and resistance levels, you can say that technical analysis is a self fulfilling prophecy.
It is important to note that supports and resistances spotted on a higher time frame are more reliable than those spotted on a lower time frame. Furthermore, big news can disrupt a technical trader’s analysis; this is why listening to news is an essential part of trading. Lastly, you can use other indicators such as Relative Strength Index (RSI indicates overbought/oversold conditions), Stochastic Oscillator (indicates overbought/oversold conditions), Parabolic SAR (buy and sell signals), or Candlesticks (bullish/bearish patterns) along with Support and Resistance to better predict the price action of a stock.
Hope you learned a little and found this blog post helpful. We talked about technical traders’ mentality, support and resistance, and the self fulfilling prophecy. As always, you can sign up for our mailing list here. Like us on our Facebook page here. Thank you!
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