Sunday, February 17, 2013

Support and Resistance (Range Trading) Strategy

Support and Resistance (Range Trading) Strategy

The concept of support and resistance trading or range trading is simple: buy when the price of the currency pair is at a valid support level and sell when the currency pair is at a valid resistance level. The key is therefore being able to identify support and resistance and when these key levels are valid enough to be used as trade signals.

A support level or zone is a price area where sellers who have driven prices downwards start to exit their positions, leaving more buyers to cause the downward slide of prices to stall. The Price of the asset will therefore find it difficult to go below that level.
For a support to be valid, it must be tested several times and be able to withstand downward pressure several times. Even if a one hour chart or a daily chart shows support being tested once, a look at the lower time frame charts such as the 1 minute, 5 minute or 15 minute charts will show if the price level has been tested several times or not. A valid support level is one that has been tested several times without being breached.
A breach of the support turns that level into a resistance level.
A resistance level or zone is a price area where buyers whose activity has driven prices upwards start to close their positions, causing a stall in the price advance of the asset. The price of the asset will therefore find it difficult to advance above that level.
For a resistance to be valid, it must be tested severally without being breached, and even if a medium or long term chart shows resistance being tested once or twice, the shorter time frame charts will reveal that the price level may have indeed been tested several times. The more times a resistance level is tested without being breached, the more valid it is. The chart below shows a resistance and support level.
Support Resistance Strategy
A breach of the resistance turns that level into a support level.
Support Becoming Resistance
Support Becoming Resistance
Trading Support and Resistance
Contract the charts using the zoom tool, so that you have a wide range of prices to examine. Then using medium and long term charts such as the 4hour chart and daily chart, you can identify areas of support and resistance, and then use these areas to trade as follows:
  • The first trade is to enter long at support and exit at resistance as the first profit target. If the move is strong enough to breach the resistance (i.e. bullish candle closes above it), then you can place a Buy Limit order at the resistance-turned support so that the retreating prices that will stall at that level will serve as a trigger for a renewed upward move. The 2nd profit target should then be the next resistance.
  • In the same vein, you can go short at resistance and exit at the nearest support as first profit target. If the move is strong enough to breach the support with a bearish candle closing below the support level, place a Sell Limit so that a retracement advance will hit the support now turned resistance, and trigger your trade for the further move to the downside. The second profit target is now the next support.
Please note that the prices may test the levels several times before eventually breaking them. So always wait for confirmation of a break of support or resistance before taking the second trade in each case.
Support Resistance Strategy
This chart illustrates a short order using our trade description. The area marked support would be the first target from the obvious downtrend which the trader would have gone short earlier on. The support was not broken, so the trader should have exited the trade at this point. Prices retreated upwards before testing the support again, this time breaching it (notice the red candle closing below the support). There were then several attempts by the price to go back to where they came from, but the support now turned resistance resisted these moves, and prices moved downwards (took a while though). Later attempts by the price retracement to breach the new resistance twice did not work.
This is how to trade using the support and resistance strategy.

Saturday, February 16, 2013

Why The Best Way To Invest Is To Preserve Capital

The stock market is very alluring to many people. It offers the chance to make a lot of money in a relatively short amount of time. However, it also carries great risk. Loss of part or even all of your capital is a real possibility.
You must decide for yourself if the risks in the stock market is worth it or if you want to find returns somewhere else. If you do decide the risks are acceptable, then your number one concern in the stock market should be to preserve your capital.

Why preserve capital?

Why should preservation of capital be your primary concern and not something else such as how much money you've made or whether your profit lags behind those of other people? The answer is very simple.

The stock market is all about using money to make money. Without the necessary capital, you cannot even take part in the stock market. It doesn’t matter how good you are in investing. You can be the greatest and most talented investor and it wouldn't do you any good. Without money, you can't participate in trading stocks.

Preserving the capital you have access to, should therefore be your primary concern once you are into equities. You must protect your capital, even if that means temporarily moving to the sidelines in the form of cash. Cash may not earn you much, but you won't suffer any losses either. Your greatest fear should be that you lose all your capital and therefore can no longer trade in equities.

The more capital you have, the easier it is to make money

Let us illustrate this with the following example.
  • Assume we have two investors with Rs100,000 in capital. Both would like to make Rs50,000 using this capital. A 50 percent return on investment.
  • Investor A is concerned with preserving his capital. His investing approach revolves around this objective. Investor B is more careless and focuses on making money at all costs in the shortest amount of time.
  • Suppose the market is now highly volatile with no clear direction. Investor A decides to wait until things become clearer and stays in cash. Investor B invests and suffers a 25 percent loss.
  • Investor B will now have to double the remaining capital of Rs75,000 to still end up with Rs150,000. A 100 percent gain using the remaining capital.
  • Investor A did not suffer any losses and only needs a 50 percent gain since he still possesses the original Rs100,000 starting capital. Investor A has a much easier road ahead compared to investor B.

Stock market advice and tips

The fewer capital you have, the harder it becomes to reach a certain level of return. The more money you have, the easier it is to make a certain amount of money. Losses have much greater impact, because we need money to make money. Limiting losses should thus receive priority over making profits. As long as you have money, you are in a position to make money. Without money, you can't do anything.

Opportunities to make profits will always come by, but you must be in a position to take advantage when that opportunity arises. That means preserving the capital for when the time comes. It is better to let an opportunity to make a profit go by, if that means risking losing your capital.. Your priority must be to never lose your capital.

What should I do before investing?

With that said, you cannot stay on the sidelines forever. People turn to the stock market to earn a high return on their capital. You cannot do this, if you always stay in cash and don't participate. At some point, you must take risk in order to make a return.

Losses of part of your capital are of course inevitable. No one is right all the time. What you can do is reduce those losses as much as possible. That means taking the time and effort to learn how to manage risk. Finding out how you can limit your losses. What kinds of insurance are there for those trading in stocks. One possible way is by hedging. There may be other ways.

You must be prepared before entering the stock market. Many people tend to jump in without any proper preparation or education and pay a heavy price for doing so. Do not become one of those people. Always remember to preserve your capital.