What is Cover On Approach
Cover on approach is an action taken to close out a profitable short position as the price drops toward an expected support level.
BREAKING DOWN Cover On Approach
Cover on approach uses a security’s support level as the basis for selling activity. Levels of support describe the lower boundary for prices the market will normally allow. Resistance to further price erosion occurs at the level of support because market participants tend to believe the price will not fall further and therefore purchase the security at that level.
Investment strategies that use a short position borrow shares from a broker with the intent to purchase shares on the open market in the future in order to cover the loan. If the price of the short security drops, the trader turns a profit because the amount they spend to repay the loaned securities will be less than it would have cost to buy the securities at the higher price they commanded at the time of the loan. In practical terms, short positions allow investors to bet on a drop in a security’s price.
Since shorts rely on selling a security at the lowest possible price after the trader takes the position, levels of support provide a reasonable predictor of where a downward trend will likely bottom out or reverse itself. By covering short positions as they approach support levels, investors seek to maximize their profits before prices rebound.
Levels of Resistance and Support
Technical analysis charts price movements for a given security to attempt to discern and use patterns in buying and selling behavior. Levels of support and resistance play a key role in many strategies based upon technical analysis because they suggest price points at which markets resist further changes in price. As prices approach support levels, market participants assume prices will bottom out or rebound. That presents a good buying opportunity, driving purchases that raise demand and bring prices back up above support levels.
Levels of resistance describe the opposite effect, where prices reach a point that market participants generally believe represents the high-water mark for a security’s price. As traders sell the security and realize profits, demand falls and prices subside.
Technical analysts note levels of resistance and support by watching the crests and troughs on price charts over a period of time. A line drawn along the troughs of a chart represents the level of support, while a line drawn along the upper bound of peaks on the chart represents a level of resistance.