How many indicators and oscillators are there that are being used for trading? Fifty, Hundred or Thousand? Well, there are unlimited numbers of indicators and oscillators that are being used or can be used for trading. Even you can make your own custom indicators. But no matter what indicators you use, price is the single most important factor in the calculation of any indicator. That’s why it is often said that price itself is the most important and reliable indicator. If you can master the art of understanding price action, you are good to go. However, to understand the price action, the single most important concept you must grasp is the Principle of Change in Polarity. This is the most widely applicable principle in the field of technical analysis. Many traders even make their living out of trading by relying solely on this principle and nothing else. Surprisingly, the change in polarity principle is also extremely simple and easy to understand. But before we get our hand on this principle, we must understand what are support and resistance.
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What are Supports?
Support is a price zone at the chart where demand is strong enough to prevent the prices from falling further. The logic behind is that as the price declines towards support, buyers become more inclined to buy and sellers become less inclined to sell. Thus, the demand increases and supply decreases which prevents the price from falling below the support level. A support level essentially acts as a floor by preventing the price from declining further.
What are Resistances?
Resistance is a price zone at the chart where supply is strong enough to prevent the prices from rising further. The logic behind is that as the price increases towards resistance, sellers become more inclined to sell and buyers become less inclined to buy. Thus, the supply increases and demand decreases which prevent the price from rising above the resistance level. A resistance acts as a ceiling by preventing the market from moving upwards.
Generally, it is not easy for the price to break the support or resistance levels. However, it is not possible for supports and resistances to always hold and breakouts often occur. Whenever the prices break the support or resistance level, there arise strong chances that the price will continue moving sharply in the same direction.
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Principle of Change in Polarity
According to this principle, whenever support is broken, its role is reversed and it begins to act as new resistance. Similarly, when any resistance is broken, it changes its role and tends to act as the new support level for the price. In other words, the former support becomes the new resistance and the former support becomes the new resistance. The chart below perfectly illustrates how a resistance, once broken, changes into support.
This happens due to a shift in the levels of supply and demand. Whenever a resistance level is breached, it is generally because something fundamental has changed in the market, and the buyers are now willing to pay even more price than before and sellers also want to sell at higher prices. This causes the price to rise above the resistance level and pushes it into new territory.
But when the rally cools-off and prices approach the former resistance (now support), the market participants remember it as an important level. Ideally, if the change was for real, then the prices should not break below this level into the older territory. Hence, traders and investors start buying at this level. Also, the short-sellers who shorted at higher levels now begin to cover their position. All this prevents the price from falling further and causes it to shoot once again. This way prior resistance level now acts as a support level.
Similarly, a breach of a support level indicates a fundamental change in the market. The buyers are reluctant to buy unless the price falls significantly and the sellers are ready to sell even at lower prices. Thus the price keeps falling and making lower lows.
When the panic fades and prices begin to climb back to the former support (now resistance) the market participants remember it as an important level. If there was really any change in the market, then ideally the price should not go back above this level. Considering this, those who bought at the lows, now begin to sell and book their profits. Also, the traders begin to form new short positions. Due to this, the price is unable to rise further and drops once again, thus forming a new resistance at the prior support level.
Conclusion
The change in polarity principle is a simple but very powerful concept in technical analysis. It is so easy that anyone can understand it. However, there is a difference between understanding and mastering. Anyone can understand it, but a few can master it. Once mastered, I don’t think there is a need for much else. How to master it, you ask. Well, to answer this I will just quote Miguel Ruiz –
“Practice creates the master.”