This is a guest post on trading from Tusk Trader (check out the newly launched site: www.TuskFund.com), an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader
Technical analysis is great tool to be aware of when trading or investing your own account. There are, however, right ways and wrong ways to use technical analysis. Here is a wrong way I continue to hear explained to me by the at home investor:
‘Hey, ABC has great support at $5.10. It used to trade around $8 but has been dropping a lot lately. I am looking for a good spot to buy. The chart is telling me there is support at $5.10, so I am putting my bid in there and seeing if I get filled in the next few days or weeks.”
Why is this wrong? Support and resistance points are not barriers that prevent a stock from trading through a price. The stronger the support or resistance point, the more volume or push it might need to get through, but it can still easily trade to the other side of the critical point you have located.
When a stock is getting close to a price you want to execute a trade at, see if the support or resistance actually does what you think it will before jumping in. There is no advantage to getting in at $5.10 when the stock blows through that support like butter and continues to fall down to $4. You should not be saying, ‘I want to be long at the support.” You should be saying, “ If the support holds, I want to get long.”
Some people I explain this concept to respond with, “But then I will have to pay up.” It is true; you could have to pay up from 5 cents to 25 cents (or more depending on the stock). A trader would rather pay up for a winner than get a “great price” on a loser.