Commander in Pips: As I’ve promised, today we will continue to deal with technical analysis and talk about support and resistance in the market.
In general support and resistance are amongst the major tools that are used in the market by the absolute majority of traders. That’s why it’s very strange, that these tools do not have a definite description – there are almost as many explanations of support and resistance and how to build them as there are traders.
On a theoretical chart the idea of support and resistance looks very clear – on an upward move as on downward:
Pipruit: Looks like resistance, despite the direction of the market always stands above it – something that does not allow market to go upward. Support conversely – holds the market from free falling, i.e. stands below the market.
Commander in Pips: Yes. When the market reaches some level above it, that does not allow it to move higher, and turns it to the downside – this particular level becomes a resistance. After a move lower, the market reaches some level below it that turns it from this level to upside move again. So, this level becomes a support. In fact, the market creates resistance and support levels over time during up and down moves.
Drawing Support and Resistance on the chart
First of all remember that support and resistance are not precise numbers, they are more areas. And the larger your time frame, the wider this area. For instance, on a monthly chart the area of support/resistance could be 100+pips, while on 5-minite chart hardly more than 10 pips. It means that even if you will see that price has temporally penetrated a support or resistance level, this does not always mean that this level is broken. It all depends on the depth and way of penetration, and here we can offer a simple and widely-applied rule: If the market has not closed below/above support/resistance then it is just testing it and this level is still valid. You can easily see it with bar chart or candlestick (charts #1 and #2). See, although the market has penetrated this level number of times it has not closed below it - close price in of all bars/candles stays above the support level (I hope you remember how to determine the close price of bars and candles). By the way, later market retests this level once again – see the touch just above our logo.
#1 EUR/USD 4-hour chart – support tested, but not terminated
#2 … so the same at bar chart
#2 … so the same at bar chart
Pipruit: So, why have you previously said that support and resistance levels are tricky? I mean although they are quite simple, all traders interpret them and use differently – you even give me the rule how to determine – has particular level been broken already or not…
#3 Is this level broken or not?
Pipruit: Wow, according to your rule – it was, but I sense that somehow it not… Yes, the market has shown a close below it, but then returned back very fast and accelerated in the opposite direction. What a move!
Commander in Pips: …and?
Pipruit: I don’t know. You’re right – it’s more sophisticated then seems before. What should we do then, how we can estimate the real breakout?
Commander in Pips: Well, maybe my answer seems frustrating to you, but – there is no definite and 100% way to do that. But, still, we have some additional rules that could help with this and increase the probability of estimation of real breakout. But before it you should understand the market mechanics of trading or support/resistance levels. This will help you much, believe me.
Pipruit: Cool!
ADVANCED COMMENTS ON SUPPORT AND RESISTANCE LEVELS
Commander in Pips: For this conversation, we will build around chart #3, but previously you should remember, what we’ve talked about stop-loss orders (if you’ve forgotten it – refresh your memory with the corresponding chapter).
ADVANCED COMMENTS ON SUPPORT AND RESISTANCE LEVELS
Commander in Pips: For this conversation, we will build around chart #3, but previously you should remember, what we’ve talked about stop-loss orders (if you’ve forgotten it – refresh your memory with the corresponding chapter).
Pipruit: Ok, I remember that – stop loss orders are usually used for limiting of potential losses if the market starts to move in direction against your position.
Commander in Pips: That’s right. Now, what we’ve talked about support area, just in the beginning of current chapter?
Pipruit: Well, support area holds market from further move down, at least temporally.
Commander in Pips: Excellent. Let’s suppose that you intend to enter Long (buy EUR/USD), and you have two possible areas where you can do that – from some support area or just in market’s free flow move, so where will you act?
Pipruit: Obviously from support – it’s safer because, as we’ve clarified already, the support area holds the market up, “supporting” it from a further move down, so the probability is much higher that the market will starts to move in my favor from support, than just from “nowhere”.
Commander in Pips: You’re absolutely right, so as other many-many traders. And, say, if you see support and open Long position – where do you place your stop order and why?
Pipruit: Below the support level because it hardly will be triggered – market will have to struggle below the support area to reach it, and why are you asking about obvious things?
Commander in Pips: Yes, so are other many-many traders… and now listen carefully:
Big players (we call them elephants or whales) see this support level also and they also want to buy here. But also they see stop orders just below the level of support, and how big value they are.
Pipruit: So what?
Commander in Pips: If the value of these stop orders is significant – they may use it in their own favor. Here is how they do that – say the market is flirting with a support area and has already shown some shallow penetrations of it but no single close below. This support level is well recognizable (say, obvious), so more and more traders see it and enter long with stop-loss orders just below this level. Suddenly “whales” are starting to sell (open shorts) positions and they sell until public’s stops will be triggered. What will happen if your stop loss on your Long position will be triggered?
Pipruit: Well, if I initially bought, hence, stop order should be “Sell EUR/USD” and will close my position.
Commander in Pips: That’s right, when price will reach your stop-loss order – you will sell EUR/USD. So, “Whales” will have a possibility to buy your position from you (your stop order) as well as other public stop loss orders. As “Whales” initially sold (have opened short position) they need to fix profits – in other words close these positions – they need to buy. So they do this with the poor public. When this transaction is over – and there is no one who wants to sell any more – then the market turns to the upside. That is what you definitely see on chart #3 during the short-term breakout below the support area.
Pipruit: But that is terrible! How they could do that and why?
Commander in Pips: Huh, my boy – don’t be naive. They want your money, everybody wants your money. This is why FOREX is a battlefield – if you do not make profit, then profit is made by someone else…
Commander in Pips:Again, FOREX is a battlefield – if you do not make profit, then profit is made by someone else…
“Why?” - The answer is obvious. First, “Whales” get profit from this short-term trade – they Sell just above the support and Buy (i.e. close their positions) just below it at lower price. Here is a profit from the “Short” trade. Second, they also can not just close their short positions, but can also create their own “long” positions by buying out your stops. And their new inventory of long positions will be made at an excellent price – just below the support area due to your stops. In fact they buy at lows. They can satisfy their greed. See – many advantages…
Pipruit: Trading is a really cruel business. But with such information I will prepare more…
Commander in Pips: That’s right son, here we are for that purpose.
So, traders call this price behavior differently – some call it “Stop licking”, Joe DiNapoli calls it “Wash and Rinse.” Anyway, the name does not change the core idea.
And now, let’s make some rules that will help you to act more successfully around support and resistance levels:
First rule remains intact – If the market holds above/below the support/resistance level and has not closed below/above it but only just insignificantly pierced it (with candle shadows), the more probable that it still valid. So, Close price is your first assistant.
Second rule - the longer time support/resistance is forming the more obvious it becomes – then the more probable is the appearance of a stop licking pattern.
Third rule - to not been trapped with stop licking (a.k.a. Wash and Rinse) you may act twofold – place your stop-loss order a bit deeper or wait until after you see a stop licking pattern as a confirmation of support/resistance strength and further upward/downward market move. After you will see, that Stop licking pattern completed – you may enter in the corresponding direction.
Fourth rule – Stop Licking is a fast pattern, so if market has broken support/resistance level (i.e. closed below/above it) and holds there for 3 periods (i.e. 3 bars/candles) or more, then probably this level has been erased by market action and not valid any more.
I hope these small and easy rules will help you to become more successful with trading around support and resistance levels.
Pipruit: There is another item I am a bit confused about, Commander. The point is that most candles have quite different shadows near support/resistance levels, and it makes it more difficult to draw the line. Does some way exist to negate this problem?
Commander in Pips: Your question is reasonable. To avoid incorrect drawing of support/resistance levels, you may use simple Line chart, that we’ve discuss. It shows close prices only, in difference to Open/High/Low/Close prices of bar and candle charts. Sometimes shadows of candles add noise to interpretation, sometimes long shadows could be just a mistake of some participant so, that we call a reflex move. The line chart instead, shows intentional movement of the market, since it links close prices, and releases you from market noise. Let’s compare them and you will understand better:
#4 GBP/USD Daily Line chart with support and resistance levels
#5 … the same chart but in bar mode
See – a bar chart, just as a candle chart, has many “tails” that penetrate support and resistance levels, so they become a bit blurring. The Line chart, in turn, looks much clearer from this point of view. But, after some time you will get more skills with support/resistance and will not need to shift to a Line chart any more.#5 … the same chart but in bar mode
Pipruit: Hey, this does really help in the beginning, but still, they are not sharp price level as you’ve said.
I will have to remember that support and resistance are areas and not the fix levels.
Also, Commander, I notice, that the same line was support and then become a resistance and vice versa – is it normal? Just take a look at the first line on previous chart – see, it was support once, but after downward breakout has become a resistance, and the latest line on the chart also…
I will have to remember that support and resistance are areas and not the fix levels.
Also, Commander, I notice, that the same line was support and then become a resistance and vice versa – is it normal? Just take a look at the first line on previous chart – see, it was support once, but after downward breakout has become a resistance, and the latest line on the chart also…
1. When price breaks, say support level, later it could retest it and this area can act as resistance. The same is true for resistance level – after breakout, it could act as support if the market will return and retest this area.
2. The more often price tests the level – the weaker it becomes, because market bounce from the level due to participants who open positions against the previous market move. Sooner or later, if market returns to this level again and again – all who wants to enter against the market – have done this, so there will not be any participants who want to open against the market. With each touching of the level fewer and fewer people are ready for entering on a counter side and eventually there will be no one who intends to do this.
3. The longer some level holds, the stronger could be the move after true breakout of this level.
4. The longer your time frame – the wider support/resistance area.
So, that’s all for today and don’t forget our previous 4 rules. I think that you can start to practice with support and resistance lines already in a demo account. What are you waiting for
Pipruit: Yeah, I’m itching to get started…Thanks.
Which is the best chart timeframe to determine true levels of support and resistance? If I use a longer timeframe - daily or weekly charts - I can easily determine the areas, and there are fewer of them. When I look at 1 hour charts or 15 minute charts, then I can see even more areas of support and resistance.
I can only place 20-25 pip stop losses, ( I do not have the money built up yet in the account to place 100 pip stops) and typically trade from 1 hour and 15 minute charts. So often I am looking at upto 5 areas of support and 5 areas of resistance on the chart - within truer levels of support and resistance idenitified from a weekly chart.
If you have the time to think about this I would be very grateful. Thanks.