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Classical Technical Analysis-Part 4

Support, Resistance

We already know that any trend is alternation of rises and downfalls, moving in a certain direction. It is possible to draw horizontal lines through these maximums and minimums. These are so called barriers on the movement ways. Price often pushes off from them, and, on the contrary, accelerates when it breaks these barriers.

Resistance is a horizontal line drawn through the price maximums.

Support is a horizontal line drawn through the price minimums.

These definitions are not strict, since an ascending trend line may be called an inclined support, and channel line may be called, respectively, an inclined resistance. The main rule is following: a support is drawn through minimums, and a resistance is drawn through maximums. For drawing a horizontal support line we need to have just one minimum, unlike an ascending trend line, which requires two minimums.

Let us consider of what use support and resistance may be to us. These levels are barriers on the price movement way. It is not so essential for a technical analyst why they appear, as the market discounts everything. We take the fact of such stop as itself into account, and further we analyze the way of price behavior at such levels. If we are in an ascending trend, a resistance breaking indicates that the ascending movement continues. If we are in a descending trend, a support breaking shows the descending trend continuation.

If price, on the contrary, pushes off from these levels instead of breaking them, every bounce increases support and resistance strength. When price appears to be between these levels, it means that a suitable situation for work within such a corridor has been formed.

At first we get convinced that a corridor has been formed. Then we use the corridor limits for trade decision making- buy from a support level and sell from a resistance level.

There is one more feature of the price movement, which may be used in our work. After break of a support or a resistance level the price often returns and pushes off from the broken level on the other side. It means that the levels retain their force, they only change their name, a support turns into a resistance, while a resistance becomes a support. For beginners such price behavior is magical and mysterious, we, however, can find explanation to it.

Note, how clearly the price was developing its return to the level on the other side after breaking.

Imagine the following situation. A trader opens a buying bargain at point “A”. However, the price breaks the level and moves downwards according to its position, or saying in stock traders slang, “minus hangs”. What do you think about the trader thoughts? As a rule, the trader hopes for the price rising back to the opening level, in order to close his bargain without any loss. In case if the market provides such an opportunity, the trader closes the order for buy, selling at the same time, and this pushes the price downwards.

Another situation. At point “В” a “bear” (a market participant, working for fall) regrets that he has not managed to open a selling bargain. Now he does not want to open it and longs for the price rising back, so that he could begin working for decrease again. If the market gives such an opportunity, the trader makes a selling bargain, which pushes the price downwards. Besides, price moves in waves. Figuratively speaking, the market breathes, breathing-in followed by breathing out. After breaking a resistance upwards (breathing-in), pullback to the level as to a support level (breathing-out) takes place. This is the market natural state, specific feature of price movement, which may be used in our work. As Alexander Elder aptly marked, support and resistance levels work at least because people possess memory. Bitterness of past defeats and joy of past victories near these levels make people reflecting on them again and again. Technical analysis via price figures demonstrates also market participants` psychology. And as human psychology has remained almost unchanged for hundreds of years, fear and greed, hope and euphoria are common for us, that is why there is technical analysis postulate that history repeats itself.

Now let us consider how to define the level strength (with an example with a resistance):

1. By number of bouncing – the more times price has bounced from a level, the stronger the level is. In case if such a level is broken, the trend may get a powerful impulse for acceleration.
2. By time
   1. The more seldom the price rose above a level, the stronger the historic level (psychological barrier) is.
   2. The nearer by time, the stronger the level – this is the feature of our memory, that we remember events happened yesterday better than those happened a year ago.
3. Volume – the higher volume at a level formation, the stronger the level is.
4. Levels at large time intervals are more important than at small ones.

In addition, do not forget, that a resistance level may later turn into a support level, and on the contrary.

Alex Sabodin.
Pro Finance Group Inc.