Thursday, May 15, 2008

Support and Resistance

Here is a great article on Support and Resistance. It's by Sam Seiden of Online Trading Academy. I receive emails from them periodically.
You read about this concept all over the web, and in books, but I have never seen it explained like this before. He explains WHY it works, and more importantly, what to look for. Time does play a role, the amount of time price spends at a price level while bulls and bears kick each other in the balls and struggle for control. This article has not only helped me understand where the low risk entries are located, but also where to place stops more effectively. If I looked to place an intraday stop, sometimes I looked at support and thought it would be at cluster lows. That was probably not the best place to put the stop. As explained in the article, look for areas where price spent the least amount of time. This is where the buyers/sellers stepped in big time to snatch up any offerings, and with one side dried up, prices moves fast. Read this article several times and understand the concept. Memorize it so you don't have to think about it. Thinking, not reacting, can get you into trouble.

Support and Resistance, a Deeper Understanding

Often, I talk about supply (resistance) and demand (support) in articles. I use simple examples and pictures to help explain how markets work and prices move. Today, let's take our level of understanding to a deeper level by actually simplifying the picture of quality support and resistance, the way we do in the classroom during the Professional Trader Part 1 and 2 courses . I was recently reviewing the pages in the stock class, and came across a page that showed what I considered something very close to the perfect picture of support (demand) and resistance (supply). The message that page conveyed to me was something I want to share with you here in hopes of improving your level of knowledge and understanding.

Price and Time: Price spends the least amount of time at price levels where supply and demand are out of balance. Price spends the most amount of time at price levels where supply and demand are NOT that out of balance.

In other words, price levels on a chart where price spends the LEAST amount of time are where the most quality trading opportunities are found. What this picture looks like on a chart is a pivot high and a pivot low, NOT a cluster of trading activity. Let's have a look...

Notice the turning points on this stock chart. If you focus on the pivot high point in the upper left portion of the chart, that provides for solid resistance when price returns to it on the 29th. That is a quality supply level. Notice the demand (support) level on the bottom of the chart, the pivot low on the 29th. Price shoots up from that level because supply and demand are so out of balance. Price spends so little time there because demand greatly exceeds supply. When price revisits that area two days later, that is the time to buy as price is revisiting a quality demand level. Next, notice the circled cluster of trading from the 28th. Price declines from that area and when it returns to that level, it moves right through it like a hot knife through butter. This is because supply and demand are not that out of balance, the cluster of trading tells us so. The fact that price spent more time in that base than it did at those pivot high and low points tells us that the great supply and demand imbalance is at the pivots, not the cluster of trading. While I may show these clusters in letters, they are for understanding. For application of support and resistance, pivot highs and lows are where the greatest imbalances are found.
Let's go over the turning points in this forex chart. Notice pivot high area "A". We call that a "pivot high" because price could only stay there for a few minutes. Why? Because supply (resistance) was so much greater than demand at that level. "B" was the first time price revisited "A" which was the low risk/high reward time to sell short. Area "C" on the chart is a pivot low. "C" happens because of a major supply and demand imbalance. There are so many more buyers than sellers that price can only stay there for a few minutes, creating the pivot low. The first time price revisited that level was the time to buy "D" as the risk was low and the reward was high. Next, notice "E", the cluster of trading that is followed by a decline in price. When price comes back to that level for the first time at "F", it goes right through it without turning lower. This is because of the time issue. Price spent more time at "E" than it did at "A" which is why "A" is a higher probability shorting opportunity (turning point) than "E". The same issue is true at "G". The cluster of trading provided no support when price revisited that level at "H". Again, time is the key issue here which is why the pivot highs and lows are the low risk/high reward support and resistance levels, not the clusters of candles.

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