This is a past article written from the old Bullbearings site on Support & Resistance, which is still valid and will help support the new online VTP Stage 1 Monthly course - which you can join on the hyper-link.
Watching how markets react to levels and zones of Support and Resistance
In my last piece (I feel the need, the need…to slow down) I commented on several things that traders could do to help improve their understanding of markets in an effort to improve their own trading.
One of the actions I suggested was instead of watching Financial TV channels or reading twitter all day was to watch how the market reacts at certain levels.
For my own view whilst there is fair amount of randomness within markets I do not believe them to be fully random. Markets are made up of people and people remember things. (I admit I’m being a tad simplistic there.) Within the markets that means that they tend to remember key levels that price has traded at in the past. This is what gives us areas of support and resistance on the charts. Let’s take a look at recent activity in the Gold chart to examine this further.
This is the weekly chart of Gold which I use to help build a big picture on what the markets are doing. It helps me build ‘Situational Awareness’ (the topic of a future piece).
On this chart I have added red horizontal lines to indicate levels of support and resistance (S&R) and drawn blue boxes around particular zones of price action at these S&R levels.
Sometimes price reacts to a certain key level; sometime it reacts to a zone of price. Certainly on the higher timeframes it’s unlikely for price to ‘turn on a six-pence’ at a specific level but more likely to respect specific zones.
As a quick glance your eye is drawn to levels and zones where the market reacted. Perhaps it bounced off one of these zones or perhaps it broke through and moved to the next level of support or resistance.
Remember when you looking at a weekly chart like this you’re looking at pretty much the same data as every other human trader. They’ll all be seeing the same zones of support and resistance regardless of whether you’re a new private trader or a hard-bitten 30 year veteran of institutional trading. You’re all looking at very similar zones and people can anticipate the next likely area of serious volatile price action. When so many people are looking at the same levels then they become a self-fulfilling prophecy. Everyone expects something to happen at those anticipated levels…and invariably something does happen.
Let’s take a look at one zone in particular depth.
The zone between $1530 and $1570 became a serious zone of Support for Gold over the last couple of years. The last time price had closed below $1570 was in the final week of 2011. Every time price came back to that zone it would pierce the zone but never close below $1570 on a weekly basis. This became a self-fulfilling prophecy where all traders looking at this chart deemed there to be sizeable support at those levels and looked to buy when price returned to these levels. And for almost the next 16 months that would have been a good trading strategy.
That is until the last week of March 2013. I wrote about it in my own blog that I was awaiting a return to the $1530 - $1570 zone. Price did return to the zone but then in one fell swoop price it sliced through both the $1570 level and the $1530 level and actually made it down to the next level of $1475. Something had fundamentally changed, we were in a new paradigm for Gold and Traders had to change the mind-set to be able to adapt and profit from the new chapter in Gold movements.
Take a look at all the weekly charts you have access to and do what I did for Gold. Just draw lines of support and resistance and identify key levels and zones. I guarantee that price will react at those levels in the future. How you actually trade off them I’ll cover in a future piece.
Till next time: trade well,
Paul