The Art of Technical Analysis
Support and Resistance: What is it and how I use it.
Read first[Important]
There is nothing magical about support and resistance levels. They are points on a chart where either buyers took control from sellers[support] or sellers took control from buyers[resistance].
The ability to trade support and resistance is an art, there is no secret or formula that will give you an edge. It takes good judgement and good judgement comes from experience and experience comes from bad judgement. Learning these things takes time.
In this lesson, I will cover:
•Support
•Resistance
•Pivot Points
•How to determine reward to risk
Support
Support and resistance are two of the most common terms in technical analysis. They both describe levels where price has a tendency to find buyers[support] and sellers[resistance].
As the above chart shows, price found support ahead of the 1.35 level. The reason for this is simple. The demand at that level was greater than supply.
It makes sense when you think about it from a traders perspective. If you were short this cross, you are naturally looking for a place to take profits. The 2015 low[left blue arrow] is a logical place to do that.
If you were looking to get long, the 2105 low is a logical place to start looking for long positions.
Since testing the 2015 low, this cross has rallied about 825 pips. We now have two data points on our chart where it was proven that the sellers lost control to the buyers. The first is the 2015 low[left blue arrow], the next is the February 2017 low[right blue arrow].
These two points are obvious and they will be used in the future as reference points for both longs and shorts.
Note: This is a weekly chart. In my experience, the support and resistance levels on longer time frames[weekly, monthly] carry more weight than 5 minute, hourly, or daily time frames.
Let’s look at a few more examples of support:
As I note on the chart[blue arrows], support is not one specific price point, like $95, but a range of price levels, $90–95.
Trendline support
A trendline is another type of support level. The only d/f is that the support level is rising instead of horizontal[see chart above].
Broken support
As the above chart shows, price found support at the 0.7600 level on 4 separate occasions, meaning the sellers could not maintain control below the 0.7600 level.
Eventually, the buyers could not maintain control at the 0.7600 level and gave up, adding to the selling pressure and causing the 0.7600 level to break.
Resistance
Resistance works off the same principal as support levels. It refers to a level(s) on a chart where sellers take control from buyers.
Note: Many traders attempt to buy breakouts. Breakouts occur when price “breaks out” above a certain level. See below.
Trendline resistance
Like trendline support. Resistance can be in the form of a trendline. See below.
The trendline held on two separate tests. I say two and not four because you need 2 points to draw a trendline in the first place. If price would have continued higher up through the trendline, it would have ceased to be a useful point of reference.
Pivot points
Pivot points are levels that were once resistance and then turned into support or were once support and then turned into resistance. See chart below.
Another example:
Let’s bring all this together. See chart below.
The chart above is an example of support and resistance levels, trendlines, and pivot points all working together to give you a good picture of where the order flow might change.
Like I have mentioned previously, there is nothing magic about these levels, but every trader using technical analysis will be aware of them and will look to trade against them.
Reward/Risk
There is no point in trading if the reward/risk is not attractive. Risk/reward is more common, but when doing the math, reward/risk is easier to work with IMO.
Before doing this calculation you need to determine two points.
1. Where are you putting your stop. This is a hard number. If you are trading forex or futures, I always recommend using a hard stop, not a mental one.
2. Your target where you will consider taking profits or moving your stop to break even.
Note: When calculating reward/risk, you are making an educated guess based on your judgement and experience. Every trade you put on will have an uncertain outcome. There are no “ sure things”. Remember that.
In other words, it is not so much what you think, but what are other traders thinking, what are they seeing, what will cause them to give up their position. You need to think through these questions and try to put yourself in their shoes because it is their orders that will push your position to either a profit or loss.
These things take experience and making mistakes over and over until you learn to execute without hesitation. You have to get comfortable not knowing how a trade will turn out. You have to be willing to give back profits if, through your analysis, you see a much bigger move.
IMO-The really big money is made in the big moves, not day trading.
This is why trading is an art, there is no formula, only a traders’s personal judgement, based on his/her experience and discipline.
Sorry for the rant, now let’s get back to it…
An example:
I am putting the words in the chart above, below.
Let’s say you took a short position off the daily chart at the close[yellow square]. Your stop is going to be 10 pips above the high for that day.
That day closed at 1.3559. The high for that day was 1.3598. Your stop would be 1.3608:1.3598+.0010=1.3608. Your risk would be 49 pips: 1.3608–1.3559=.0049 or 49 pips.
Your target is the 1.30 level. I picked that level because it has been “proven” that price has had a tough time breaking below it. That is 559 pips:1.3559–1.31=.0559 or 559 pips.
So your reward/risk would be your “potential” reward of 559 divided by your “known” risk of 49: 559/49=11.41.
If you risked $100 dollars, you would make $1,141 if you took profit at your target level of 1.30:$100*11.41=$1,141.
Note: Just because you pick these levels does not mean price will get to them. Price could stop half way or a quarter of the way to your target, reverse and stop you out. That is why it is important to write down why you took the trade, where you will take profit, and where you will get out if you are wrong[your stop].
Experienced traders, me included, are not exempt from making these mental errors. I occasionally take profits too early when I planned on holding it.
It’s hard.
That is where experience comes in. I have found that the pain of not being in a big winner, because you took profits too early, is far worse than losing a small percentage of your account.
In conclusion
I hope this lesson has been helpful. If you are confused by something I wrote, have further questions, or spotted an error please email me at thecorner@tradesam.com.
Caleb
