If you’re a trader of stocks, I’d be willing to bet that you keep a close eye on earnings.
With good reason, of course: A stock’s price almost always follows the same path as its earnings.
Personally, however, as a chartist, I’m much more interested in a stock’s price action than its balance sheet.
Specifically, I watch to see how shares react to earnings before making any moves.
Because, while fundamentals are important, of course, they’re reflected in the share price.
In conjunction with forces of supply and demand, fundamentals drive a stock’s price action.
When a chart is broken down into its most basic factors, everything comes down to these two simple elements.
A Dynamic Duo
If you’ve been following my reports, you may have noticed that I often write on the subjects of support and resistance.
They’re the bedrocks of technical analysis – better known as the study of securities, using historical price and trend data.
Support and resistance are, simply put, boundary levels on a stock’s chart, to which its price reacts.
A stock is always bouncing off support and slamming up against resistance. The so-called war between the bulls and the bears plays out at every such boundary.
For instance, when it’s reported that a stock is “breaking out,” the bulls have pushed it above its projected resistance. Conversely, when a stock “breaks down,” the bears have dragged it below support.
If a trend holds, however, previous measures of resistance will often become support, and vice versa.
Some common recurring levels include round price numbers ($10, $20, $50, $100), popular simple moving averages (20, 50, 200), and 52-week high-lows.
What makes these levels so powerful at controlling price action?
They don’t have much intrinsic value based on numbers alone, but much of their influence comes down to market psychology.
Traders are taught to know that a significant number of buyers and sellers will be waiting to trade at these key points.
Nevertheless, it’s more important not to get caught up in the reasons behind fluctuating individual support and resistance levels.
Rather, let’s talk about how to put these margins to work for you.
Follow the Footprints
A stock in an uptrend will test many points of resistance as it ascends the chart.
When shares finally break through resistance, a rush of new buyers will come into the market in hopes of making a quick buck. Resistance, therefore, becomes support and sets a new floor.
The stiffer the resistance, the more significant the new support level will be within the market.
This means a breakout above resistance can be a great buying opportunity, because shares enjoying new support can rear a substantial profit.
On the other hand, a stock in a downtrend tests many support levels as it falls, pushing up against its own boundaries. If you’re looking to take the short side of shares, a fresh breakdown below a support line can represent a fantastic selling opportunity.
Thus, both the “breakout” and “breakdown” offer opportunities to profit. It’s just a matter of understanding your openings.
Best of all, you can apply these concepts to almost any charted financial security.
Stay tuned: Next week, we’ll break down the pivotal breakout of the S&P 500 using what we’ve covered today.
In the meantime, keep your eye on the market as it reacts to earnings, rather than just the earnings, themselves.