Sunday, December 21, 2008

Trading Support And Resistance

Do you think you could earn your fortune from one horizontal line? If that horizontal line was a conga line of rich millionaires with holes in their pockets, then certainly you are a big chance. Throw on a Hawaiian shirt, fire up some Beach Boys and you are on your way. For those not fortunate enough to be invited to the last Donald Trump Bar Mitzvah, there could be another way (although granted the first way sounds much more fun).

The theory behind Support and Resistance is really very simple, when price turns and doesn’t return to it at the point of observation, that is resistance or support.

When you see a bounce off support like we did at the closing hour of the SP500 yesterday, trading these levels seems splendidly easy. Of course, as is everything else to do with trading, it isn’t as easy as first glance. Here is the counter-argument for trading Support and Resistance on the SP500.

Six identified support are resistance areas, six failures, not such a good method at all then is it. Recently while getting my thai strethcing massage and a pedicure, I printed out ten years worth of data on the AUDUSD spot currency pair. On it I marked the clear weekly support and resistance levels. I then tested how many of them held for at least one retracement, an attempt to be realistic with real time trading practices.

The result from this study was that clearly many others don’t do the same due diligence. The results were not pretty, well below 50% success. Taking these levels at face value obviously isn’t going to cut it in the age of the smooth equity curve.

Clearly something else is needed to help identify those that hold, so I took advice from the most experience market expert in the business, who has been telling traders what to do for centuries, price. Let’s go back to the chart of ugliness, the six out of six loser chart and see where price told us that a support or resistance level was going to hold :

  1. A strong bar up with a close at it’s absolute high, next bar gapped slightly and closed up, certainly no indication there of a reversal.
  2. A consistent run up into resistance, even an aggressive trailing entry behind each low would not have got you in here, again no sign.
  3. The only one that gave a hint of a turn, a small reversal bar with a lower close bar to follow, the stronger move up compared to the smaller move down either side of the pivot might have hinted of a lack of follow through, but really that is hindsight analysis, so a loser there.
  4. A very small pause bar at support, looking for confirmation next bar gave us a strong momentum bar below support, no signal there.
  5. Finaly another strong bar up intro resistance, no low was taken out, so no signal until the high right at the top of shot.
Six levels, only one of them gave even a hint that it was going to hold. Simply listening to what price is telling you would have kept you on the sidelines avoiding the carnage that the blind traders had to endure. Now to look at the opposite scenario, when price does hold, this time on the Dow Jones.

  1. This is the kind of thing authors eyes get attracted to, it is also what cause sweeping statements about trading support and resistance in public forums. This time price gives us a sign, a move to support, an inside bar to indicate indecision, and a nice momentum bar with a lower tail to indicate the bulls are in control.
  2. Not so effective, but a signal none the less, a move to resistance, and nice big long doji bar, and a small move down off resistance. Not a retirement trade, but certainly a chance to lock in break even.
It is clear when trading support and resistance it’s just as important to listen to price as it is to have your fly done up. If you don’t, you are in for some embarrassment in hindsight. Listening to price can give you hints about whether a level will hold, whether you apply it to support and resistance, fibonacci (don’t get me started), or any other mathematical bullocks you like.

Listen to price as though the Greater Power is speaking directly to you, as the market too is bigger than all of us, it just speaks to us a little more often.

Related Posts :
  1. Buyers vs Sellers
  2. Reading Price Action

Sources :
  1. Trading Support And Resistance | Written by Akuma99, October 24th, 2008 at 4:19 pm.

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