DINEO TSAMELA: Trend lines, support, supply and demand: just some of the tricks of the trade
Distinguishing between trading and investing is essential to understanding which tools you need if you are to be successful.
Investing is all about the long term. It requires in-depth analysis of the prospects of a share or bond or any other security. If an investor is looking to invest in a company, they would consider the company's long-term prospects.
On the other hand, traders are concerned with short-term movements, be they intraday, daily, weekly or monthly.
Fundamental analysis underpins long-term investment strategies. If investors are considering buying a particular share, they would look at company fundamentals such as management, past performance, future projects and expansion plans.
Investors will also dig into the company's financial statements to find out its intrinsic value. Traders, on the other hand, rely on technical analysis which focuses on the price movement of the security in which they plan to trade.
The methodologies employed in technical analysis have come under great scrutiny, but many traders still use them to try and identify opportunities.
Technical analysis is essentially noting the effect of supply and demand on a security. It relies on the pattern of a securities movement and aims to use it to predict the next likely movement. This means technical analysts rely heavily on historical data and trade volumes.
Technical analysis has three underlying assumptions:
- The market value of securities is determined by the dynamics of supply and demand and the share price has factored in all known dynamics. This dynamic means that analysts will ignore fundamentals and simply focus on the current price, a function of supply and demand at that moment;
- The price is likely to move in a repetitive pattern, whether it's over the short, medium or long term; and
- History is likely to repeat itself.
Trends are important in technical analysis, because they help analysts see a pattern in market movements. A trend is a composition of movements in the price of a security. Trends can show upward, downward or sideways movements.
In addition to evaluating the direction of the trend, a trader will look at the length of the trend before it breaks. A short-term trend contributes to an intermediate trend. Short-term trends will give direction on price movements over shorter periods. Intermediate trends will be a series of short-term trends. They will also eventually contribute to a longer-term trend, over a period of 12 months or more. Traders will therefore use a trend chart to map out trend lines. Trend lines can be used to join low or high points in a security. These will help traders figure out where support and resistance levels lie within the trend. Trend lines can be used in short-, medium- and long-term trend analysis.
Support and resistance levels are important in the analysis process.
The support level is the lowest price a security is likely to reach, while the resistance level is the price above which a share is unlikely to rise.
You'll often hear traders or security analysts refer to support and resistance levels in their reviews. The support and resistance levels are not set - they tend to move with the trend. Once a stock pushes above a resistance level or drops below the support level, it may indicate the beginning of a new trend.
Support levels may trigger a buy signal for traders, while resistance levels may call for a hold or sell option.
This is only the tip of the iceberg when it comes to technical analysis. There are plenty of materials that will help you navigate the complexity of the trading environment. It's also worth following trading communities on social media and participating in trading forums.
• Tsamela is the founder of piggiebanker.com