During the American Revolutionary war Patrick Henry uttered his famous request, "Give me liberty or give me death". Of course, life only guarantees two things, death and taxes. In the end Patrick Henry got the only one that he could count on, death. Perhaps Patrick Henry should have instead demanded, "Give me life or give me death". It wouldn't have been so inspiring or memorable, but he might have actually survived his capture by the British. The fact is that while not all choices are equal, all choices do have an equal counterpart. The British obviously did not see the choices provided by Patrick Henry as being equal.
What Patrick Henry failed to comprehend about choices is something that we do well to learn ourselves; all things of great importance come in comparable twos. There is a husband and a wife, night and day, a yin and a yang, a left and a right, and an endless array of other two's that are interconnected, whether they happen to be balancing choices or opposing forces. So it shouldn't come as any surprise to learn that there are also two great opposing forces in trading, support and resistance
Support and resistance levels are one of the basic tenants of technical analysis. In many books and courses it is among the very first lesson taught because so much is based on its foundation. The concept of support and resistance focuses on price levels that prior market activity couldn't exceed and so these levels are expected to put up a roadblock whenever price approaches them again. If they are exceeded then it is considered a strong sign that price will continue for some time and that the former
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support or resistance will act as a guard preventing price from retreating out of its new territory. It is as if price has a fence that isn't easily crossed.
If price manages to cross it then it is with great effort and will in turn require greater effort to jump back to its former side. Therefore, it isn't hard to realize the importance of understanding support and resistance when it comes to trading.
There is only one problem with this concept. Support and resistance will frequently fail and cause many a trader to take a substantial loss. For example, one very common trap is called a "false breakout" and this is where a market will exceed the resistance or support level just enough to fool traders into thinking that the market is about to make a substantial move. So they jump in only to have price promptly return to its former side, which guarantees a loss for every trader fooled by the move. It is not that the concept of support and resistance is flawed, but rather the problem lies in the method for determining support and resistance. How so?
The method of determining support and resistance is based on a horizontal view. That is, wherever price set a high or low and then reversed in the past this is the price level that you would use as support and resistance in the future. It remains at that same level throughout all future price activity.
For example, let us say that a market reached 1 00 and promptly reversed direction, establishing a major high. Two months later when price reaches this level again the normal method of determining support and resistance would dictate that 100 should stop any further progression of price. I f price rises to 1 0 1 then it would b e expected to continue higher with the former resistance level of 100 now becoming support. Sounds logical and at times it would be correct, but surprisingly the use of horizontal levels for determining support and resistance is often just plain wrong.
Considering how pervasive the belief is that support and resistance is set on a horizontal plain I have no doubt that this statement comes as a bit offensive to some. But the reality is that horizontal levels are static in nature and the markets are anything but static. So if horizontal levels do not accurately represent true support and resistance, what does?
Defining true support and resistance
True support and resistance is more accurately defined as, "Levels that have established themselves within the flow of a market by mUltiple limits on price action."
Channel Surfing
This means that a true support and resistance level will have mUltiple highs and lows establ ishing a line of support and/or resistance. You will rarely find multiple support and/or resistance points at the same exact price level. It does happen, but usually they are offset to some degree. What will be the normal course of discovery is that these l ines will be diagonal in nature similar to what we have already seen with channel lines, only these l ines are used in a slightly different way.
To emphasize this point, while support and resistance will from time to time establish themselves horizontally most true support and resistance levels are actual ly diagonal and inclined either upward or downward.
This distinctly different definition is an important basis for understanding why a market will tend to exceed some levels and still fai l to sustain that move or why a market appears to lunge early in a large move even before it actual ly breaks a prior high or low. When you redefine support and resistance levels beyond the traditional view it becomes clear why certain events happen the way they do and the true deciding moment.
To help clarify this definition and what we are actually talking about here let's look at few examples found in figures 9-1 and 9-2.
Each of these lines touches multiple highs and lows. as well as flow through gaps to create a spider web and establishes true support and resistance
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Flowing through this chart is an intricate web of support and resistance
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The majority of true support and resistance exhibit themselves diagonally with either an upward or downward incline. This means that they are constantly changing their actual price limit. They intertwine throughout price action, impeding price whenever it approaches. There are times when price will shoot through or even gap pass these lines with great power, but that is to be expected in order to break through a brick wall. Other times price will break through, but has difficulty letting go and will linger for a whi le. However they choose to exhibit themselves, they will continue to reassert their power time and time again. They will even traverse huge voids of a chart and sti l l reestablish their force at a later date.
Like a spiders web, the intertwining of true support and resistance can be quite extensive and as numerous as the strands of a well-spun web. At other times there may only be a few "strands". Many are very subtle so it takes an eye for detail and a patient individual to find them. There is no rushing this process. A quick glance at a chart will almost certainly guarantee that you will miss some key support or resistance level. Find them and the rewards can be fantastic.
To appreciate the benefits of patiently looking for these subtle l ines let's take a closer look at a few examples and notice the impact that they had in figures 9-3, 9-4 and 9-5.
Channel Surfing
This line has four points of support and/or resistance extending over a substantial distance
Whenever you see support and resistance reaffirmed over a long distance. then it is a
strong line and should be watched
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The subtlety of true support and resistance will make identification a l ittle more difficult than that of traditional support and resistance levels, but they are well worth the extra effort. Mastering this skil l will take some practice because it doesn't come automatically. But there is a real benefit in that it gives you the ability to recognize what is really happening in a market showing you where price is likely to stop and reverse or even gap.
I n fact, gaps will often be the first clue as to where many of these lines are actually located.
Characteristics of true support and resistance
There are a number of unique characteristics that are associated with true support and resistance. One such example can be seen when two or more of these l ines intersect and cross one another. The market tends to have a strong reaction that starts with attraction. Price will strive to reach an intersecting point even if it is against a current trend. But at the same time these intersecting points are also taboo for price and it will normally avoid actually touching them. Most of the time the market will stop short and pull away, but occasionally it will choose to gap over it instead.
Obviously, this tendency is one worth remembering. I f a trend is approaching an intersecting point then it is quite likely that a pullback will occur just before it actually touches it, delaying a trend and possibly reversing direction. So when price hesitates you will already know why
Channel Surfing
and will have been expecting it. Of course, there also is the possibil ity of price actually gapping over this point, or at least making a quick move through it. This is not as common, but does happen frequent enough.
Knowing this helps you to understand why a gap may appear out of the blue for no apparent reason. Usually this type of gap is not worth getting overly excited about because the market is only trying to deal with a point that is too hot to handle, but the ability to recognize the reason and difference can be of great value.
Another characteristic involves trends that are actually headed away from an intersecting point and how they react to the time of that intersection.
Just before reaching the specific time of an intersection a trend will often come to a complete halt and reverse direction in an attempt to reach it, even though it is much too far to actually do so. Sometimes this will result in a complete reversal, but more commonly it will only create a pul lback that ends as soon as the intersecting point passes. What this means is that this knowledge can provide a key entry or exit point based on time that you would otherwise not have. In the case of a trend that forms a pul lback, the intersecting point may very wel l be the ideal time to enter a prevailing trend.
There are always exceptions to any rule but the attraction that price has for intersecting points is unmistakable. A few very pronounced examples of this phenomenon can be seen in figures 9-6 and 9-7.
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One of the most powerful reactions related to intersecting true support and resistance levels occurs when price is caught between the converging l ines. As they come together they create a powerful force that "squeezes"
price as they converge closer and closer together. As the distance narrows pressure builds up until price finally succeeds in exploding through one of the l i nes. This is a great set up for an option trader who is looking for a low volatility straddle trade. I n a straddle the trader buys cal l and put options and will profit as long as the market moves sufficiently in either direction. I f the market fails to move enough, then a loss will be taken. So this situation meets the criteria that a successful straddle requires.
Taking a look at a pattern we have used in the past as an example, the triangle displays the characteristic narrowing of support and resistance levels and usually results in a price explosion from the built up pressure.
This provides an easy model for us to appreciate how this effect works.
But what we are really describing here goes much further than just a simple pattern and is actually drawn on support and resistance levels that many would assume had lost their influence on a market long ago. This insight of market behavior is what creates a profitable trading opportunity that will normally leave other traders dazed and confused. Anytime that you find true support and resistance levels putting the "squeeze" on price then you are l ikely to find an opportunity for a quick profit when it finally breaks. And you don't have to be an option trader to take advantage of this either. By looking at the overall trend and determining which direction the odds favor for the market to move, a trader can enter while a market
Channel Surfing
is calm and exit after it has exploded and run its heart out. Notice how in Figure 9-8 a wedge pattern was already outlined by true support and resistance lines even before price was trapped by them. The squeeze could only result in one thing, price rocketing toward new highs.
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The converging of support and resistance levels offers some very nice profit opportunities. But what if you are dealing with only one l ine? Do singular levels of support and resistance offer any trades? The answer is a resounding yes.
Singular support and resistance levels are by themselves a source of strength to price movement and price will use them as a resting place, a springboard and as a home to return to. One line by itself cannot guarantee that it will stop or support a trend, but the odds favor that it will. The key to gauging the strength of a particular l ine can be found in what it has demonstrated in the past. The more a l i ne has provided support or resistance as price touched it the more powerful the move will have to be in order to actually break through.
So what you can count on with support or resistance levels is that they will either continue to support or resist price, acting like a brick wall, or when they actually do fai l then price is l i kely to make a substantial move.
So trading becomes a simple matter of taking action based on what price does at these pivotal junctures. If a line has supported price several times in the past, then buying as price reaches this line once again would be the logical step to take. If you buy and it stil l breaks through the line then
Michael 1. Parsons
you simply reverse positions and sell, expecting the price to drop even further. While it is best to use the overall situation to judge a trade, the basic concept boils down to this simple rule; you use what happens at the support or resistance level to determine the trade you will take. Assume it will bounce off a support or resistance line, but if it doesn't then accept the small loss and reverse positions.
This approach is basically the same strategy that we discussed earlier when using channels to make our trading decisions. The difference here is that you are now looking at the internal interweaving of support and resistance that flows through the market to gain an additional edge. In the majority of cases you will find that every pullback, reversal and pause in the market can be predicted based on these lines. New support and resistance levels will appear and old ones fade away, but rarely wi 11 you find price that is not guided by these lines in some way. Figure 9-9 provides numerous examples of just how much each swing in GE is guided by these lines.
Although subtle. notice how the highs. loVJS and gaps are dictated by support and resistance lines formed
by prior highs, lows and gaps
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Support and resistance levels habitually stop the advancement of price like a brick wall. In spite of this aversion for crossing them, price does seem to be a glutton for punishment and will butt up against them every chance it gets. These lines act like magnets and will draw price like a moth to the flame. The stronger a line resists price the stronger the attraction seems to be. Even if price wanders a considerable distance, just give it half a chance and it will come running right back again. This is one of the reasons it is important to keep track of true support and resistance levels even if they haven't been used for quite a while. They are likely to resurface and
Channel Surfing
become support or resistance again. As it is true in the case of channels, it pays to monitor larger time frames because older and stronger support and resistance levels will be easier to find this way. This is another way that multiple time frames will add to your trading success. The difference in perspective can be considerable as figures 9-10 and 9-1 1 show.
A strong trend that has already lasted a year
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Although subtle, true support and resistance lines provide an incredible insight into market activity and are wel l worth the effort necessary to search them out. While it is true that these l ines can be quite extensive
Michael 1. Parsons
and numerous, most every reversal, pause and gap can be explained by means of them. They have a predictive quality that can provide an edge that is simply not possible with most forms of chart analysis. Additionally, certain lines can even be more definitively classified and attributed with specific characteristics that can refine market analysis even further. One example is that of the center line.
Center lines, the magnetic center of trends
Most l ines repel price, which is why the concept of support and resistance works in the first place. Still, price is a glutton for punishment and will run its head against a brick wall of a support or resistance line every chance it gets, so an undeniable attraction exists as well. This appears to be a bit of a contradiction, but isn't that true of many aspects in life? A man and woman may fal l in love, get married, and raise children that they both absolutely adore, yet repeatedly fight and argue with one another, make up, and a few days later fight like cats and dogs all over again throughout the life of their marriage. There are more than a few marriages that repeat this type of cycle over and over again, where mates will butt their heads against one another constantly. Similarly, price will keep butting its head up against any line that develops as well. But there is an exception to the
Most l ines repel price, which is why the concept of support and resistance works in the first place. Still, price is a glutton for punishment and will run its head against a brick wall of a support or resistance line every chance it gets, so an undeniable attraction exists as well. This appears to be a bit of a contradiction, but isn't that true of many aspects in life? A man and woman may fal l in love, get married, and raise children that they both absolutely adore, yet repeatedly fight and argue with one another, make up, and a few days later fight like cats and dogs all over again throughout the life of their marriage. There are more than a few marriages that repeat this type of cycle over and over again, where mates will butt their heads against one another constantly. Similarly, price will keep butting its head up against any line that develops as well. But there is an exception to the