Support and Resistance: More Than Meets the Eye

 

Introduction
Support and resistance are quite possibly the most basic market concepts right after demand and supply. In fact the two are undeniably linked. If traded properly S&R can offer extremely high reward at delightfully low risk. To make the most of S&R we need to understand human psychology and how it affects the losing majority of market participants

 

As pointed out in 'The Market Holy Grail: Fact Or Fiction?' trading is about the trader him/ herself rather than the indicators available on their charting package. The novice trader who is still susceptible to fear and greed, amongst other negative emotions, is part of the psychology of the masses. Just like in any other vocation the professional charges the novice for a service and this is how he/ she makes their money. Of course consistently profitable traders don’t charge the novice but their profits are derived from beginners’ losses.

So how does the novice think at support and resistance? To understand this fully let us concentrate on human nature. As humans we find it comfortable to buy when the market is going up, when news is good and vice versa when the market is going down. When there is a rally underway we feel ‘safe’ following its direction. However, this frequently offers us high-risk entries. At this point every other novice (some 90% of the market) is having the same idea. This results in a climactic rally that can push prices into support or resistance. The masses are not paying attention to this however. How can they think of bucking the trend at a time like this? The fact that nobody else is left to jump on the bandwagon is the last thought on his or her mind and they never see a possible reversal point.

Picture one illustrates this precisely. At point ‘a’ things couldn’t be looking worse for the bulls. There is a momentum bear candle which is the result of heavy selling and possibly some bad news. However point ‘b’ points out that the market is coming towards some hefty daily support.

The trading minority are fully aware of this daily support and of the market psychology that took the price to these levels. Because they know exactly how the masses work they are presented with a low risk entry. If the majority are short then there is unlikely to be anyone left to force prices even lower. This will create a reversal point and momentum on the upside will increase as the masses liquidate their short positions. Picture 2 shows the market rebound from point ‘b’ up to a daily resistance zone ‘c’.

Of course S and R zones don’t always hold. When there is sufficient bullish or bearish sentiment the market can gain further momentum and break out. Therefore the goal is not to pick the top or bottom it is to spot the turn in price. This can take the form of candlestick and price patterns. Not all S&R points have to be market tops or bottoms. If this were true the market would be in a constant range. S&R also comes in the form of pullbacks as part of a larger trend. If we zoom out from our previous example we can see that the daily support at point ‘b’ was the low of a previous pull back. By trading with the larger overall trend we can increase the odds of picking a profitable position still further.

Clearly there is a lot more to S&R than meets the eye. By looking at mass psychology we can avoid the dangers of the herd mentality. For any day traders out there not paying attention to the larger picture you can see that there is cause to do so. How many times has an intra day rally turned on you and left you without the clearest indication why? Next time you miss an entry point and the market powers away from you think about the psychology of those in the same position as you. Rather than chasing the market and entering at a high-risk area, calm yourself and wait for the masses to offer you a low risk entry.