Imagine you are walking across your roof while looking for damage from the hail storm last night. Suddenly the support under your feet crumbles and you fall through. If you are wearing a secured harness, everything is fine.
If not, your life could be changed forever.
When walking across a roof, the worst feeling in the world is the support under your feet suddenly crumbling. Even if you are protected by a safety harness, there will be a few terrifying moments. If not, the results can be devastating.
When support for an asset crumbles in the markets, unprotected traders can see their accounts suffer severe damage as well. The difference is, those traders who are prepared will have a safety harness on their trading account. They can also turn potential disaster into spectacular winnings.
What constitutes support levels in the markets?
A roof structure provides support under the feet of anyone walking on top of it. It is clearly visible to anyone who looks.
In the markets, we can look at price movements as footsteps and apply some simple technology to make the support that exists under prices just as visible as a rooftop under your feet.
The underlying support becomes clearly visible.
When does support crumble?
On a roof, the support gives way when the integrity of the structure begins to dissolve. It is much the same with price support in the markets.
Support levels are established at the point where buyers step in over and over again to open new positions and prevent the price from falling any further. It is also the point at which selling pressure seems to exhaust itself.
When buyers refuse to step in at the previously established level, the market crumbles beneath our feet and our trading account plunges along with the asset price.
When buyers refuse to step in at the previously established level, the market crumbles beneath our feet and our trading account plunges along with the asset price.
As the image shows, the fall can come suddenly!
Like a crumbling roof the price support in the market can vanish quickly.
How do you put a safety harness on your trading account?
Imagine the sudden panic if you were to step down on what you thought was a solid roof and it suddenly collapsed and you fell right through!
Would it be any less frightening if you experienced the same thing suddenly happen with your trading account? One moment everything is fine and your positions are on solid support — then instantly the support is gone and they are plummeting lower.
Experienced roofers use safety harnesses to protect them from these failures of support. Traders can use protective stop orders.
How can this prevent losses?
A safety harness for anyone working at heights is a protective device they wear with a strap attached to a body harness. The strap is attached to a fixed, secure point and limits how far the person wearing the harness can fall before it saves them.
A protective stop in the market works much the same way with trading positions. It is usually placed a bit below the established support level and immediately closes an open position when price support collapses.
Just as the safety harness protects a roofing professional, a well-placed protective stop saves the trading account of an experienced trader.
How can you win with this?
If you are walking on a roof, having a safety harness that prevents you from taking a terrible fall is a HUGE benefit. When you place a “safety harness” on your trading account positions with protective stops you protect your trading account from severe falls as well.
Avoiding a major loss is always good, but winning is even better. If you are now asking yourself how to take advantage of this potential disaster you just avoided…CONGRATULATIONS! Now you are thinking like a trader!
When support has collapsed for an asset in the market, it creates the perfect opportunity to sell short and bank attractive rewards as the price moves lower.
As traders, it is important to keep in mind that every situation presents us with the opportunity to not only avoid a loss but the chance for a win as well.
Avoid the losses and throw in some wins!
Support can crumble at any time — always be prepared
Roofs and markets can both be unpredictable entities. Everything can seem fine one moment and be in total collapse the next.
When a roof gives way beneath our feet the best we can hope for is to be protected and avoid catastrophe. In our trading accounts, we can apply a harness for protection but we can also position ourselves to benefit from the collapse.
All that is required is a little time to use a few simple tools and readily-available technology, and your trading can not only be safer, but more rewarding as well.