This is probably as good of a time as ever to get back to basics.
Let’s try to remember what this is all about.
What the hell are we doing here anyway?
I won’t speak on your behalf, but I’ll tell you the way I look at it.
The reason Technical Analysis works is because we’re identifying trends.
And Prices trend.
Earnings can be helpful sometimes. And other times no so much. Fed policy can be helpful sometimes. In other times it’s not.
But you know what is ALWAYS helpful? Price.
It’s all that pays anyone.
And besides, it’s the only truth in all of this.
But what does that mean? “Price”
You hear it all the time. Price this, price that. Price pays.
But how does it pay exactly?
Support and Resistance. That’s it. That’s all you need to know.
Support is a level in a declining market trend where there is a temporary halt due to more buying pressure than selling pressure.
These are the “troughs” in the market. They’re reaction lows where demand overwhelms the amount of supply.
Resistance is the exact opposite of support.
Resistance is a level in a rising market where there is so much more selling pressure than buying pressure, that there is a temporary halt in the uptrend.
These are the “Peaks” in the market, or reaction highs, where supply exceeds demand.
Since there is enough selling pressure here to overcome any buying, prices stop rising and reverse back down again.
A break above resistance is considered to be bullish, while a break below support is considered to be bearish.
You can see all the broken support for the current stock market in last week’s note: Buying Broken Support Is Not The Best Strategy
Meanwhile, in these charts described above, you can clearly see where support and resistance come into play.
The red dashed lines represent where prices stopped appreciating and for whatever the reason, supply now exceeds demand. Same on the flip side where prices stopped falling and for whatever the reason, demand now exceeds supply at that particular price point.
Remember, we don’t care “why” prices stop falling. We’re just observing the market proving that this is indeed the fact.
Here it is one more time:
One can’t argue against the fact that at these resistance levels, there is more selling pressure than buying pressure. Same thing on the way down. These support levels are recognizable and are very clear.
It is a fact that at these levels, prices stopped going down and reversed up because there is now more demand than supply, for whatever the reason.
These supply and demand principles detailed above can be applied to all liquid assets: stocks, indexes, ETFs, commodity futures, forex, interest rates and definitely Crypto.
So when we refer to a “market” or a “security”, these words are being used to interchangeably describe a liquid free market.
These principles can also be applied on various time horizons. You could be looking at a 20 or 30 year weekly or monthly chart, which many would consider long-term, and you could also be analyzing short-term daily charts, or even intraday.
The one thing I will say is that the larger/longer the time horizon in question, the more powerful these principles above tend to be. This is due to the amount of volume taking place at these key turning points. Obviously 20-years of resistance, for example, is going to be much more difficult to penetrate than 20-minutes of resistance on say, an intraday 1-minute chart.
The added value of recognizing support and resistance is that they are constantly turning into the other. You’ll often see former resistance turning into support and former support turn into resistance.
This is what we refer to as the Principle of Polarity.
This is what Edwards & Magee said almost 70 years ago:
…here is the interesting and the important fact which, curiously enough, many casual chart observers appear never to grasp: these critical price levels constantly switch their roles from Support to Resistance and from Resistance to Support. A former Top, once it has been surpassed, becomes a bottom zone in a subsequent downtrend; and an old Bottom, once it has been penetrated, becomes a Top zone in a later advancing phase
For example, Industrials have recently run into resistance.
Prices were in an uptrend, and then stopped going up when supply overwhelmed any demand for Industrial stocks. This was over 8 months ago and remains the case today.
A breakout above this resistance would be a bullish development:
At the same time, throughout this 8-months of consolidation, there are also a series of troughs. This is the support, where there has been more demand than supply for Industrials.
A break below this support would be a bearish development.
Here’s a great example of broken support.
If you own bitcoin, you’re making a conscious decision to own an asset that is below broken support. Why would you want to be long below all this overhead supply?
“But JC I’m a longer-term investor. That’s too short-term for me”.
So let’s zoom out then.
Look at all this support under 30,000 for BTC over the past year.
Do you think that will continue to act as support? It certainly can. In fact, it probably will.
But what if it’s only temporary and that support breaks.
Is that too short-term for you as well?
Will you continue to hold under those circumstances?
For us the answer is so easy.
We don’t have to answer that question because there’s already been no reason to own it.
Laser eyes and HODL are just memes, not actual strategies.
There’s no reason to be long here anyway, so there’s no question to answer if BTC breaks those summer lows.
It probably will.
In fact, I hope it does.
Let me ask you this, when you don’t own something, but would like the opportunity to buy it way cheaper, do you also hope it keeps getting smoked?
Or is that just me?
Are we supposed to feel guilty for having those feelings? Because I definitely don’t at all.
I hope it gets back to single digits.
It’s not my problem. It’s only the problem of the people who decide to ignore the basic supply and demand dynamics I described above.
And what about US Stocks?
Look at all that support in Small-caps that broke:
Are you going to own small-caps below all that resistance?
I don’t see any advantage in doing something like that.
It’s a death wish, as far as I’m concerned.
Talk to me if $IWM is either back above all those broken levels, or if it’s much lower near some ancient support that may hold one day in the future.
Right here, owning small-caps is no better than being a bag holder in Bitcoin.
I like buying things that are breaking through resistance, not falling beneath support.
Here’s a good example. We’ve seen a ton of relative strength the past few months from Brazil. We’ve also see a ton of relative strength from Energy.
So here’s a Brazilian Energy stock pushing up against resistance:
Do we want to own $PBR if it’s below resistance like it currently is right now?
No, that would be somewhat equivalent to the Small-cap and bitcoin bag-holding above.
We only want to be long $PBR if it’s above all that resistance.
See the difference?
Supply & Demand. Support & Resistance.
That’s what this is all about.
Nothing else matters.
So What’s The Plan?
What are we doing about the current circumstances?
How are we applying these supply and demand principles in current markets?
On Friday we broke down the largest companies in the world outside the United States. This has been where we’ve found leadership recently. And we want to be buying breakouts in those names showing relative strength & positive momentum. Check out the International Hall of Famers here.
Commodities were the best performing asset in 2021 and so far in 2022 we’re seeing the same thing. There are plenty of ways to take advantage of these trends, in both the stock market and outside of stocks. We want to be buying the ones breaking out above resistance.
Our trade ideas page is constantly filled with a list of names that are either breaking through resistance or finding support. But in either situation, the risk is always very well-defined and the potential reward is exponentially greater than that defined risk we’re willing to take.
Have any questions? Email me or just pick up the phone and call: 323-421-7991
We love to hear from you.
Even if it’s just to say what’s up.
Have a good week.
Remember, only people who want to be bag holders own assets below broken support.
Don’t be a bag holder.