BEFORE YOU TRADE, KNOW YOUR LINGO!


Marketing & Business
piece written on the 2nd April 2014 by  

Although I’ve been trading shares for about a year, my knowledge is still nowhere near where I would like it to be. I’m learning as much as I possibly can in and around running the company, but I keep coming back to something I told a friend: Investing with¬†uncertainty is like going to the casino and throwing some money on a roulette table. What I have done during the past year though is try to learn as much as possible. However, the most important thing in my opinion is to take the time to read about the various terms that are used. All articles, white papers, blog posts and the likes use a lot of lingo and if you don’t know what longs, shorts, resistance, etc. are, you’re going to struggle to learn. (Side note: getting your fingers dirty is up up next to knowing the lingo, don’t just read, act!).

This post was inspired when I read a tweet that actually caught me for a second whilst I figured out exactly what was meant:

It’s quite a mouthful and although it’s not the most technical statement, without a basic understanding of the terms such as long, resistance and stoploss, it’s quite tricky to act upon it.

Long Position (aka Long)

Buying long is when you buy a share with the expectation that the share will rise in value, so long positions make money in a rising market. For example, if you see a share such as BHP Billiton rising over time then you would buy the share long.

Short Position (aka Short)

Buying short is when you buy a share with the expectation that the share will fall in value. Typically someone would do this to then buy back the shares at a lower price. In other words, short positions make money in a falling market. For example, if you see a share decreasing in price and feel that it will increase again in the future, you could sell your shares and then buy them back at a lower price before they rise again.

Stop Loss

This one’s quite simple, a stop loss allows you to assign a value to a share and once that value is reached, the share is bought or sold. Generally when I trade, I would buy shares, let’s say at R322/share and I’d put a stoploss on R300/share – meaning that if the share drops to R322/share then my shares would be sold. This allows you to minimise your loss and I believe it was Warren Buffet who speaks about cutting your losses rather than trying to ride the wave out.

Resistance Level (aka Resistance)

The resistance level refers to a level/price that a share keeps reaching but cannot go past. For example, if you’re holding shares in MTN and over the past several months the share reached a specific price but never goes higher, this specific price would be the level of resistance. The more times that a share unsuccessfully tries to break through the level of resistance, the less chance that the share will break through.

As you can see below, a level of resistance around $38.8 keeps being reached but not surpassed. Chances are that the stock will drop now, this wouldn’t be a good time to buy in.

Resistance

Support Level (aka Support)

Similar to the resistance level, the support level is on the lower side of things. Instead of being an upper level price that a share cannot move past, the support level is the price level which, historically, a stock has had difficulty falling below. In many cases one might say that the support level is a very good time to buy into a share.

Here is an example of a support level of around $51.25:

Support Level Example

Breakout

A breakout is a stock price that moves outside a defined support or resistance level. A breakout trader enters a long position after the stock price breaks above resistance or enters a short position after the stock breaks below support. Once the stock trades beyond the price barrier, volatility tends to increase and prices usually trend in the breakout’s direction. The reason breakouts are such an important trading strategy is because these setups are the starting point for future volatility increases and large price swings. In many circumstances, breakouts are the starting point for major price trends.

There is a lot more to breakouts that I’ve shared, it would be worth reading this article if you’re interested.

As you can see below, the price broke out at around $105 and then rocketed to an all-time high of $128.

Breakout Example

To revisit the initial tweet, let’s break that down:

This Twitter user is recommending that you buy into IMP at R120 because the stock broke through resistance and will hopefully go as high as R128 per share (R8/share increase). But because it broke through resistance, it will be volatile and therefore let’s put a protection (stoploss) in place in case the volatility results in a decline so we can get out at R118.

These terms are incredibly important if you’re interested in technical trading. Traders around the world share their opinions and these opinions mean absolutely nothing if you can’t understand what they’re offering – this puts us back at the roulette table.

If you’re a trader and I’ve explained anything incorrectly I’d really appreciate being corrected.