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§5.1 Lines and levels

How to use a technical analysis

As previously mentioned, technical analysis is a tool used for trading among most traders. Is it difficult to master? No, it isn’t but if you will still need to adhere to the principle of consistency and develop skills immediately on a demo account.

It should be noted that technical analysis dates back to ancient times. It existed 500 years ago when there were much fewer traders. They gathered on the real stock exchange floors and had to draw charts by hand. But even then, those traders understood that technical analysis could earn good money. There is no doubt that it is much easier to use technical analysis nowadays: a program draws a chart by itself – you just need to select a chart type and define coordinates. The fundamental techniques of technical analysis are not complex at all. We shall try to consider all of them.

Lines and levels are the simplest methods which allow forecasting. How are they drawn on the chart?

To draw a level you need to draw a horizontal line through the highest/lowest point on the current chart. It will be a resistance level (if it is above the price) or support level (if it is below the price).

To draw a line you need to draw a straight line through several “tops” and “bottoms” on the current chart. The more of them and the more important they are the stronger the line will be. Depending on the line’s position towards the price they bare the same names as the levels.

уровни и линии

How to use lines and levels? Traders developed several simple methods long ago which work in most cases.

  • If the price approaches a line or a level then it is more likely to “bounce off” it than to “break” it. It means that when the price approaches closely to the boundary you can place a bet for a reverse movement. This is the action that the price usually follows.
  • If the price crosses the boundary after all it will more likely “hit” the boundary from the opposite side. That is the (upper) resistance line turns into the lower boundary in relation to the price – the support line. It is remarkable that the line can be still useful for you.

Notice that you can draw a score of various lines on any chart but it doesn’t makes sense to do it. You should focus only on those lines and levels which are the closest to the current price and focus on the fact that, in the past the price “bounced off” it many times. Of course the lines have more strength on large time frames than on small ones.

The first version of a trading strategy

Trading on resistance/support levels and lines is the simplest but very effective trading strategy.

The simplest trading strategy looks something like this:

  • We make a trade (buy an option) if the price approaches the support level and “bounces” off it in the opposite direction.
  • The buy is made with the view of
  • The buy is made with the view of prices going in the same direction in which the bounce was made. For example, if the price hit the lower support line, then it will more than likely move up now.
  • The line on which the calculation is made must have enough “strength” that is it must have evolved for a long period of time. It would be good if several “bounces” were made off of the line in the past.
  • The signal must be confirmed by something else so that you can make a trade on its basis, for example, by one of the indicators or Japanese candlesticks’ graph. We will discuss these applications in the following chapters. Having said this, lines and levels are very effective signals compared to many indicators that you can use.

If the price breaks the level it is also a good signal to use. Truly speaking, many traders expect that the price will first “nail down a success”, that is bounce back to the level from the opposite side, bounce off of it and then go further. It allows you to reduce the risk of incorrect prediction.

§5.2 Trend continuation and reversal patterns→