The stock market is a wild place where fools are often parted from their money. It is also a place where fortunes are accumulated by the wise. Besides the fool and the wise, the stock market is also a place where gamblers, speculators and punters play with their luck. It is also an ideal place for the sly to practice their bag of dirty tricks. Today, we will look at one of their dirty tricks.
Back in Crowding at the exits, we mentioned that:
One popular idea among technical analysis is the concept of a ?support level,? whereby stock prices are expected to ?rest? on and rebound from. Traders often place their ?stop-losses? on the support level, which is the price level that they will sell their stocks in order to cut their losses. As the stock price rests on some traders? stop-loss levels, it triggered their stop-loss sales of their stocks. Such sales put downward pressure on the stock price, which may result in other stop-loss levels to be breached, which in turn triggered even more stop-loss sales. The outcome is a very steep and rapid fall in stocks prices.
Such widespread use of technical analysis can present an opportunity for the well-resourced foxes. Stock prices often fluctuate within a range. The lower bound of the range is called the ?support? level and the upper bound is called the ?resistance? level. Traders using technical analysis may see any breakthrough out of these two levels as significant because such an event signals a change from the status quo. Thus, they may place their stop-loss price (the predefined price in which existing holdings of the stock will be liquidated if the stock price fall to it) below the support level.
What would these foxes do when the stock price approach the support level? As you may have guessed by now, they would sell the stock (either from their existing holdings or borrowed) in order to push down its price to below the support level. This in turn will instigate a wave of selling. The outcome is a very rapid drop in stock price that the foxes can then exploit for their benefit.
Tags: resistance level, stop-loss, support level, technical analysis
