What Exactly is “Support and Resistance”?
All forms of technical analysis use the terms “Support and Resistance”. Very few traders look into exactly what that means. Why is a given level support, or resistance? What makes it support? Do I sell resistance? What can I expect when a market trades to support? What if support turns out not to be so “supportive”? What does that mean? What is that telling me? Why is it telling me that? Is it magic? Is support and resistance derived in some objective and consistent fashion? Is there any statistical validity to determining support and resistance in a given way? How many ways are there of determining support and resistance? Does my method of determining support or resistance help me to determine whether or not to take a trade? Can I effectively trade my way of determining support and resistance?
If you are a trader ask these questions of your favorite method of determining support and resistance. It will be a very illuminating exercise.
In my work that focuses on using auction market principles and the profile graph to analyze markets and make trade decisions, I make an effort to stay away from the terms “support” and “resistance”. Instead, I use the term “Key Reference Areas (KRAs)” (link to Jan 5 article). These are areas that can be both consistently and objectively identified. They are more accurately described as inflection points as opposed to support or resistance. They are not “magic”; there is a logical reason they are inflection points. Also, unlike typical ways of determining support and resistance a consistent if/then approach can be used in formulating trade decisions from these areas that have a valid edge.
Each individual completed day has KRAs. A group, or composite, of days has KRAs. KRAs are where there is a valid edge to consider entering trades. It helps open to define the trade selection process. It helps to eliminate randomness from one’s trading. It helps to eliminate overtrading. It assists in determining logical targets for one’s trades.
Below is a chart of the March S&P mini. There are two composite profiles that comprise trade activity in the ES since January 13. The ES is trading in Globex on Monday evening as I write this near the mid-point of the range (the current price is highlighted). There is no edge at present; it is a coin flip as to which extreme is reached first – upper or lower. A trade with an edge is taking a trade from either near 1143-1144.50 or 1128.75-1127.50. “Edge” in this instance refers to the probability that a trade from either of these two areas has a reward to risk that is much greater than random (1:1). It does not matter if the trade is a long or short – the edge is derived from knowing where to attempt the trade.
This is obviously a much different way to analyze and trade markets than the techniques the overwhelming majority employ. But then again, why would you want to be doing what everyone else is doing if 95% of them are losing money.
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