Support and resistance levels
Support level – is the prices level which has a rather big potential for buying with the purpose to stop and upturn the price fall. Support level is shown on the chart by a horizontal or almost horizontal line, which connects a few bottoms.
Resistance level is precisely the opposite. It is better to draw lines through the accumulation boundary, but not through extreme points; because the boundary shows the place, where most traders have changed their opinion. Whereas, the extreme points correspond to the panic sentiments of the weakest players, who can be easily overwhelmed by emotions. Weak resistance and support levels result in trend pauses, the strong levels are able to turn the trend. The reasons for the resistance and support levels’ existence are: memory (experience), headache arising from increasing losses on the losing open deals, as well as regretting the lost profit (of the insufficient volume on the open profitable deals).
The strength of support and resistance
The strength of support and resistance depends on three factors: the duration, its height and trade volume. The longer the support or resistance line is, i.e. the bigger its duration and quantity of trend touches, the higher it is. But support and resistance levels can become outdated.
The wider the limits of support and resistance are, the higher the strength is. The bigger the volume at support and resistance level us, the upper it is.
The rules for traders
1. Set up a stop order for closing losing positions.
2. Distinguish long-term from short-term support and resistance levels. The long-term have a higher value.
3. Support and resistance levels should be used for placing the orders to close losing or profitable operations. The recommendation from Edwards and Magee is not to close the position at round numbers (the play against the crowd’s psychology). But at present, everybody is already closing at fractions.
Real and false break of support or resistance level
Fluctuations on the market happen within the range, but not along the trend line. Most of the range breaks are false. They are so–called “poison bait” for amateurs and luck for professionals. The latter suppose, that generally, the prices vary without deviating too much. As soon as they see the break reaching its new upper levels, they open the position in the opposite direction. The correlation risk vs. profit here is so good that the professionals can afford a mistake by half while estimating the time, and they will still gain profit. The best purchasing moment during the break upwards on the 24-hour diagram is determined by the results of the week’s diagram analysis, which shows a new rising trend start. Real breaks are followed by a big amount in trade, while false ones are usually accompanied by few trading operations. Real breaks are also verified by new extreme measures of technical market indicators, which are changing towards the trend direction, while false breaks usually bring about chaotic price and indicator changes.
Support and resistance levels around the pivot plot.
There is a technique of support and resistance levels estimation - The Pivot Point for Trading. It is applied in intraday trading and is effective on the markets with considerable price changes during one day.
The daily pivot point: P = (H yesterday +L yesterday +C yesterday)/3
Resistance of the 1st level: R1 = 2P-L
Support of the 1st level: S1 = 2P-H
Resistance of the 2nd level: R2 = P+(R1-S1)= P+(H-L)
Support of the 2nd level: S2 = P-(R1-S1)= P-(H-L)
Resistance of the 3rd level: R3 = R1 + (H-L)
Support of the 3rd level: S3 = S1 - (H-L)
If the prices have broken the pivot point above, one should open a long-term position with a stop loss at the pivot point level. If the prices went under it, one should open a short–term position with the same stop loss. As soon as the 1st level of support is reached, one should close, but if the prices have crossed it- the stop loss should be moved to that level. One should act similarly when the 2nd level of resistance is met further.
For support levels the actions are symmetrical.
Support and resistance levels around the meridian (methods 1/3-2/3)
There is also a simple method of support and resistance levels estimation, according to the meridian:
Resistance level: R = H - (H - L)/3
Meridian level: M = (H + L)/2
Support level: S = L + (H - L)/3
Support and resistance levels, which are counted according to the mentioned methods, are also called Tirone levels after the name of the analytic John Tirone.