Trend, Support, Resistance, and Change in Polarity
At its core technical analysis is the interpretation of market trends. In fact, it does not work as well in a market with no discernable trend.
The simplest and most important trend in technical analysis is price. From a technical perspective a downtrend reflects an increase in selling pressure whereas an uptrend shows an increase in buying pressure.
Defining a trend for technical analysis
- A market is trending up if we see successively higher high prices that retrace to higher lows
- A market is trending down if we see successively lower low prices and retracement to lower highs
We can identify these trends using a trendline.
- A trendline in an up market is drawn by connecting the low prices of each period
- In a downtrend the trendline is drawn connecting the decreasing high prices
Here is an example of a daily trading chart showing both up and down trends:
The longer a trend persists the more significant it is thought to be.
A breakout occurs when the price goes above or beyond that trendline by a significant amount.
Support, Resistance, and Polarity
Breakouts are important because they reflect a push “through” the support or resistance level and can reflect a reversal of the previous trend.
- A support level is where we would expect an increase in buying demand to support a price
- A resistance level is where we would see increased selling to prevent further price increases.
Outside of trend lines, both support and resistance can appear at “psychologically important” prices like round numbers.
Polarity is the technical concept that once a support or resistance line has been breached it flips and the opposite trend becomes dominant. So, if prices fall below a support line, that support level is now a new resistance line and vice versa. It looks like this:
Combining trend with support/resistance patterns: