GET Financial Education Series - Futures
Technical Analysis: Trends, Support and Resistance – Lesson 7
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Futures are rising. Futures are falling. If you watch or read financial
news reports you will have seen or read people talking about Futures moving
up and down. Of course it is not the Futures themselves that are moving
up and down but rather the prices of those Futures that are moving up and
down. Futures prices change daily. Your job as a Futures trader is to learn
to identify where the prices are going to go next.
Futures traders keep track of where Futures prices have been in the past
using Futures price-charts. By keeping track of where Futures prices have
gone, Futures traders are able to more accurately project where Futures
prices are going to go in the future. This process of analysing past Futures
prices to determine future price movement is called technical analysis.
Technical analysis is considered by most traders to be somewhat of an art
form that takes time and practice to master. Get started today on the path
to becoming an accomplished technical analyst by learning the following
foundational concepts of technical analysis:
- Trends - Where prices may be going
- Support and Resistance - Where prices may stop and turn around
Trading with the Trend
Identifying the trend and trading with it is vital to your success as a
Futures trader. The Futures market can be an emotionally charged place and,
when traders start pushing the price of a Futures contract in one direction
or another, other traders typically start to follow suit and push the price
of the Futures contract in the same direction. When you see increasing momentum
building behind a moving Futures contract then the chances are good that
the Futures contract will continue moving in that direction. At that point
you increase your odds of making money by trading with the trend. Fighting
the trend generally turns out to be a losing proposition.
Trends tell you where prices will most likely be going in the future. If
traders are pushing the Futures contract price higher then you need to buy
the Futures contract to make money. If traders are pushing the Futures contract
price lower then you need to sell the Futures contract to make money. If
traders are in disagreement over where the Futures contract price should
go and are pushing the Futures contract price sideways then you either need
to alternate between buying and selling the Futures contract or wait until
the trend points up or down to make money.
Trends do not move straight up or straight down. They typically move higher
or lower in a stair-step fashion. Upward trends often move higher for a
while and then give up part of their gains before turning back around and
moving higher again. Conversely, downward trends often move lower for a
while and then regain a part of their losses before turning back around
and moving lower again. Trends move in this stair-step fashion because different
traders have different outlooks on where they believe Futures contract prices
are going to move in the future and they place their trades accordingly.
These trades cause the Futures contract prices to move up and down within
the same trends.
When a majority of traders believes the Futures contract price is going
to move in one direction they can overpower the minority of traders who
disagree with them. When this happens the Futures contract price begins
to trend and will usually move in one direction for a while until the majority
loses momentum. As the majority loses momentum the minority can momentarily
exert its influence and push the Futures contract price in the opposite
direction to retrace part of the previous movement. However, once the majority
catches its breath and decides to resume building momentum, it will turn
the Futures contract price back around and continue in the original direction.
Every time a Futures contract turns around and begins moving in the opposite
direction it forms a new high or a new low. New highs form when a Futures
contract moves higher and then turns around and moves lower. New lows form
when a Futures contract moves lower and then turns around and moves higher.
Identifying these highs and lows allows you to identify whether a Futures
contract is in an upward trend ('up trend'), a downward trend ('down trend')
or a sideways trend.
Up trends - Futures contracts that are trending upward form a series of
higher highs and higher lows (see Figure 1).
Figure 1 - Up Trend
Down trends - Futures contracts that are trending downward
form a series of lower highs and lower lows (see Figure 2).
Figure 2 - Down Trend
Sideways ('range bound') trends - Futures contracts that
are trending sideways form a series of highs that are at approximately the
same price level and a series of lows that are at approximately the same
price level (see Figure 3).
Figure 3 - Sideways Trend
Trends - whether they are up trends, down trends or sideways
trends - can form over various time periods. Identifying the following trends
over each timeframe and being able to align them in your analysis is crucial
to your success as a Futures trader:
- Long-term trends
- Intermediate trends
- Short-term trends
- Aligning trend timeframes
Remember that Futures prices
move up and down in up trends, down trends and sideways trends. The key
is identifying where the Futures contract is establishing its highs and
lows.
Long-Term Trend
Fundamental factors are the major drivers of a Futures contract's long-term
trend. As fundamental factors cause demand for a commodity to increase
or supply to decrease, the price of the Futures contract typically moves
higher. As fundamental factors cause demand for a commodity to decrease
or supply to increase, the price of the Futures contract typically moves
lower. Whilst the fundamental outlook for a commodity can literally change
overnight, the trends established by a commodity's fundamental outlook
tend to last for a while.
Long-term trends, sometimes called major trends, are those trends that
have dominated a Futures contract for the longest period. Looking at this
daily chart of Crude Oil (CLM8), you can see that the price has been rising
in an up trend from left to right - notice the series of higher highs
and higher lows as time progresses (see Figure 4).
Figure 4 - Long-Term Trend
When you see a strong up trend like the one on the chart for Crude Oil
then you know that traders are eager to buy this Futures contract and
you should consider doing the same if you want to make money from this
price movement. If the trend on the chart for Crude Oil had been pointing
downward then you would consider selling the Futures contract to take
advantage of the price movement.
Next you need to look at the intermediate trend to see if it is trending
in the same direction as the long-term trend.
Intermediate Trend
Intermediate trends, sometimes called minor trends, move more rapidly
than long-term trends because they cover a shorter period of time. These
trends are also affected by fundamental factors. Looking at this daily
chart of Crude Oil you can see that the price has not moved straight up
as it has followed its long-term up trend. It has had periods when the
price has moved sideways. It has also had periods when the price has fallen
(see Figure 5).
Figure 5 - Intermediate Trend
Notice that, whilst there have been periods when the intermediate trend
was moving both sideways and downward, the long-term trend was still moving
upward. Trends tend to move in a step-like fashion. Rarely do they move
straight up or straight down.
Seeing this price action should confirm your bias toward buying Crude
Oil. However, it should also tell you that whilst your bias is bullish
(you think the Futures contract price is going to move higher) then you
may want to wait to buy the Futures contract until you see the intermediate
trend move upward - and in line with the long-term trend.
Next you need to look at the short-term trend to see if it is trending
in the same direction as the long-term trend and the intermediate trend.
Short-Term Trend
Short-term trends, sometimes called 'micro trends', are more volatile
than both long-term trends and intermediate trends because they cover
the shortest period of time and they are predominantly affected by the
news of the day. It is not uncommon to see these short-term trends change
direction extremely rapidly. Looking at this hourly chart of Crude Oil
you can see that the Futures contract price was in a down-trending short-term
trend at the beginning of the chart - notice the series of lower highs
and lower lows as time progressed (see Figure 6).
Figure 6 - Short-Term Trend
Notice that whilst the short-0term trend was moving downward the intermediate
trend and that the long-term trend were still moving upward. It is possible
to have different trend timeframes moving in different directions at the
same time.
Seeing this down trend on the hourly chart would have prevented you from
taking a bullish trade on Crude Oil at that time, even though the intermediate
and long-term trends were bullish. However, since it is the only the short-term
trend you should not abandon your bullish convictions toward Crude Oil
just yet.
In fact if you look at the end of the hourly chart for Crude Oil you
can see the short-term trend changing direction - which may bring all
three trends into alignment.
Aligning Trend Time Frames
Your most profitable trading opportunities will come when the long-term,
intermediate and short-term trends all line up in the same direction.
Just as it is easier to swim downstream instead of upstream against the
current, it is easier to trade with the trend than against it. When the
long-term, intermediate and short-term trends are all moving higher it
is an excellent time to buy a Futures contract. When the long-term, intermediate
and short-term trends are all moving lower it is an excellent time to
sell a Futures contract.
You can see in the chart of Crude Oil that the trend for each timeframe
has been moving higher for the past few months and that the price of Crude
Oil has shot higher. Had you purchased this Futures contract, then held
it through this most recent rally, you would have made a large profit
(see Figure 7).
Figure 7 - Aligning Various Trend Timeframes
Understanding trends is only half of the basic technical analysis picture.
To complete the picture you also have to understand the concepts of support
and resistance.
Paying Attention to Support and Resistance
Support and resistance levels are like the ends of an Olympic swimming
pool. Just as the ends of the pool tell swimmers when it is time to turn
around and start swimming in the opposite direction, support and resistance
levels tell you if the price of a Futures contract is likely to stop,
turn around and start moving in the opposite direction in the future.
Knowing where a Futures contract may stop and turn around helps you to
enter and exit your trades at the most profitable times.
Support is a price level at which a Futures contract tends to stop moving
down, turns around, and starts moving back up.
Cut Outs
Support levels illustrate important psychological levels in the Futures
market.
Support levels form because of the following:
- Futures traders who missed an earlier buying opportunity decide
it is a good time to get into the trade
- Futures traders who bought the Futures contract decide it is a good
time to add to their positions Futures traders who sold the Futures
contract decide it is a good time to take profits
Resistance is a price level at which a Futures contract
tends to stop moving up and then turns around and starts moving back down.
Cut Outs
Resistance levels illustrate important psychological levels in the
Futures market. Resistance levels form because of the following:
- Futures traders who missed an earlier selling opportunity decide
it is a good time to get into the trade
- Futures traders who sold the Futures contract decide it is a good
time to add to their positions Futures traders who bought the Futures
contract decide it is a good time to take profits
Support and resistance levels are not precise price points. Rather they
are general price ranges. When you are identifying your support and resistance
levels you should picture yourself drawing them in with a large marker
instead of a fine-point pen. For example you are only going to frustrate
yourself if you try to pinpoint a price level of 1410 on the S&P 500 Futures
contract as support. You will be much better off if you identify a price
range of 1400 to 1420 or 1390 to 1430 as support. Give your support and
resistance levels some room to be flexible.
You will find that support and resistance levels come in many shapes
and sizes. To become a successful Futures investor you will need to learn
to recognize the following:
- Horizontal support and resistance
- Diagonal support and resistance
Horizontal Support and Resistance
Horizontal support and resistance levels form as Futures prices rise
up or fall down to the same price level time and time again. You can see
these support and resistance levels take shape on charts of the Futures
contracts you are interested in trading as the prices move back and forth.
Looking at the Euro FX (ECM8) chart, for instance, you can see that certain
price levels (indicated by bold black lines) acted as strong levels of
support and resistance. From November 2007 through to the early part of
February 2008 the 1.4400 price level served as support for the Futures
contract price (see Figure 8) whilst the 1.4800 price
level served as resistance.
Figure 8 - Horizontal Support and Resistance
Imagine you had bought the Euro FX Futures contract in late February
at 1.4800 as it was breaking up and through resistance, and that it was
now approaching 1.6000 again after bouncing off support at 1.5400. Knowing
that this level has been a significant resistance level you may consider
exiting your Euro FX trade so you can realize your profits before the
Futures contract price turns around and begins moving lower.
Once you feel comfortable identifying horizontal levels of support and
resistance you can move on to diagonal levels of support and resistance.
Diagonal Support and Resistance
Diagonal support and resistance levels, you will find, can be a trader’s
best friend. Whilst these levels can be more difficult to identify when
you are just getting started, they are invaluable when you are analysing
a Futures contract that is trending. Remember that you want to find trending
Futures contracts because it is much easier to make profitable trades
when a Futures contract is trending.
As you look at the charts of the Futures contracts you are interested
in trading you will begin to notice that these Futures contracts will
often form higher highs and higher lows (or lower highs and lower lows)
as they increase or decrease in value. The lines that connect these highs
and lows are your diagonal support and resistance levels.
Looking at the Crude Oil (CLM8) chart which we were looking at earlier,
for instance, you can see that the price was creating a series of higher
highs and higher lows in early 2008. If you connect all of the highs with
a diagonal line and all of the lows with another diagonal line (indicated
by bold black lines) you will be able to see the diagonal levels of support
and resistance that were affecting the price of Crude Oil (see Figure
9).
Figure 9 - Diagonal Support and Resistance
If you were watching Crude Oil you would wait until you saw the price
fall back down to the up-trending support level before you bought the
Futures contract. Once you were in your trade you could then watch for
the price of Crude Oil to rise up to the up-trending resistance level
before you exited the trade and took your profits.
The real trick to effectively investing using support and resistance
levels is to combine both horizontal and diagonal levels in your analysis.
Horizontal and diagonal support and resistance levels exist concurrently.
Your Futures contract charts have a wealth of information locked within
them and they are waiting for you to unlock that information with simple-but-effective
technical analysis techniques.
Long-Term Trend
