Trading Skill #3: Determine if S/R Will Hold/Fail Flashcards
How to determine if s/r will hold/fail?
- If you expect a support area to hold, you will buy as the market test the support area
- If you expect a support area to fail, you will sell as the market breaks below the support zone
- The key to a correct judgment is patience, waiting for more price action clues is the best course of action when in doubt
How to Define Support and Resistance
- They are price levels(area) where traders expect that a change in market direction is more likely than random
- A support level is an obstacle to falling prices
- It acts as a price floor
- When the market gravitates towards a support level, we expect more than a random chance of halting
- A support level is an obstacle to falling prices
- A resistance level is a barrier to rising prices
1. It acts as a price floor
2. When the market gravitates towards a resistance level, we expect more than likely to stop ascent - Important to remember S/R levels are zones
How to mark a support and resistance level?
1. How to mark
2. How to judge(analyze)
3. How to trade
4. How to avoid pitfalls
Type 1: Market Structure Projections
- Peaks are swing highs. Troughs are swing lows
- Together peaks and troughs form the fundamental market structure
- We can mark s/r by connecting and projecting from swing pivots
- S/R levels are extensions of the market structure
- 3 main ways to project s/r from market structure
1. Projecting a horizontal line from one or more swing pivots
2. Connecting 2 swing highs and casting the line
3. Connecting 2 swing lows and casting the line
- The horizontal levels projected from the swing pivots are the most basic form of s/r
Type 2: Projected With Computation
- Fibonacci Retracements and Extensions
- Andrews Pitchfork
- Speedlines
Type 3: Price Action Formation
- Price Gaps
- Congestion Zones
- Measured Moves
Type#2: Price Gaps
- Price Gaps( Breakaway Gaps): When a price action breaks out of an area of consolidation. It signals the start of a new trend. It may reverse the market direction or start a trend from any consolidation pattern
- Although breakaway gaps kickstart trends, not always
- Different Types of Gaps:
-Breakaway Gaps- Starts a trend -Runaway Gaps- Continues a trend - Exhaustion Gaps- Ends a trend - Common Gaps- Insignificant( fills to quickly)- How to Identify a Breakaway Gap:
- Gap out of a consolidating chart pattern
- High volume( crucial for bullish breakouts)
- Does not fill quickly
- Event Driven Breakaway Gaps: They are powerful price occurrences. Thus, it’s uncommon that they form without underlying events( earnings, important announcements)
- Major fundamental events drive the formation of breakaway gaps
- Tracking critical events that affects stocks helps confirm
- Particularly relevant for position traders who combine TA/FA
- See low volume within consolidation base and high volume on the B.Gp
- Focus on breakaway gaps that have the support of the trend. Look at the market’s direction before it started consolidating. A breakaway gap in the same direction bodes well
- The gap distance gives a hint at the power of the trend
- Methods
- % of price change- normalize gap distance with stock price
- ATR Multiple- Distance of Gap/ATR=Significance of Gap
- Chart Formation-Gap Distance/ Height of Chart Pattern. A higher number represents a more notable gap- Projected Targets From Chart Patterns- All breakaway gaps hop away from consolidation patterns( wedge/triangles). The height of these chart patterns offer basis for projecting a price target
- The space between candlesticks are critical
- Identifying consolidation patterns great way to prepare
- B. Gaps offer the best risk to reward ratio
- How to Identify a Breakaway Gap:
Type#3 Congestion Zones
- Congestion Zones: Simple price action that takes at least 3 bars to form. Price congestion is a concept, not a right pattern. It is sideways price action
-How to respond to Congestion Areas: 1. Support and Resistance 2. Trade Exits 3. Warning Zones #1 Congestion Zones as Support and Resistance - Project solid support and resistance zones - Using high volume formations as support and resistance - As market moves sideways, trading volume is concentrated within tight price band, forms effective support and resistance #2 Congestion Zones for Trade Exit - Trends tend to drift sideways before pull back/reverse - If you’ve managed to join a trend, use sign of price congestion to tp - Congestion patterns at midday and towards the end of the session makes a strong case for immediate exit #3 Congestion Zones as Warning Zones - When market congest for prolonged periods, consider it a warning - It cautions you that the potential profit is limited - It is wise to stay out of prolonged sideways action until you observe more concrete price action
Type#4: Volume Formations
Volume Represent market Interest, and this interest manifest is a significant support and resistance
- Extreme or concentrated volumes are reliable signals
- Climatic Volume - Candlestick Charts
- Market Profile
- Price by Volume
- VWAP - Price By Volume- A price by volume(PBV)is a horizontal histogram plotted on a chart, showing the volume of shares trading at a specific level
- Used to illustrate high buying/selling interest at a specific level - Indicative of price levels over a certain period of time - Generally used in conjunction with other TA - Also known as “volume by price charts” - Understanding a Price by Volume Chart
- It’s common to see securities face little resistance between levels that have small PBV bars - Price may experience difficulty moving above or below areas with large PBV bars - Delineate the difference between buying and selling volume by shading sections green or red - Price volume chart shows total volume certain price level over a period of time, this means projected support and resistance levels may be outdated
VWAP- Is a unique intraday trading tool for assessing the market bias
- Avg price of all transactions within trading session
- Accounting for volume as the session progresses
VWAP Formula= Total Dollar Amount Transacted
———————————————-
Total Shares/Contracts Traded that Day
Key Points
- Based only on the price and volume data of current session
- Used to measure trading efficiency for large institutional orders. For instance, you manage to execute a buy order at an average price lower than end of day VWAP
- More sensitive to the price and volume changes at the beginning of the session. Less as session progresses
- Due to Progressive lag, might not be good for timing market entries
- Valuable tool that reduces market noise and illuminates price bias
How to Use it To Determine Market Trends
Step 1. Look for a push away from the VWAP
Step 2. Observe if that push enjoys follow thru or is rejected back 2 VWAP
- If the thrust away from the VWAP enjoys follow through, assume a trading session. You can then consider momentum trades in the direction of the trend
- If the market rejects the price thrust back to the VWAP, assume a sideways session. Consider taking mean reversal trades
Type #5: Computed Levels
Examples:
- Moving Averages
- Volatility Bands (Bolinger)
- Calculated Pivots
Type #6: Psychological Support and Resistance
As market psychology underpins TA, these simple methods can be very effective depending on market trading
-Round numbers
- 52 week high and low
Organize Them With These 3 Spectra:
Reactive-Predictive
Static-Dynamic
Projected-Computed
- Reactive/Predictive: We identified react to zone by observing where price has traded, volume concentrated, both. The key here for you that s/r zones are marked based on where the market has traded. We’re reacting to past info. Examples: Swing pivots, areas of congestion, price gaps
For predictive zones, the market has not traded there yet. We predict that the level will serve as a support and resistance zone. Examples: Fib extensions, trend lines, moving averages
- Static/Dynamic: Some form of support and resistance remain the same once marked and are not update=Static Zones. Examples: Horizontal zone projected from a swing pivot
There are also pure dynamic zones that are updated constantly w/each incoming price tick. Example:: Most computed s/r zones
- Projected/Computed: Projected support and resistance rely entirely on price features and geometry. Closer to underlying price action. Computed S/R like MA’s are indicators
Section #2: How to judge the significance of s/r level
- Analyzing the likelihood of a s/r area holding up is the crux to forming a trading strategy
- Answer the following questions to perform analysis:
…How many times has the market touched the s/r?
- The more times s/r touched the more established s/r
- Each time market test s/r it removes some potency
- For instance each time market touches a support level it removes some eager buyers, support fails
-When the market does touch support and resistance how those PA look?
- Each time the market touches support and resistance examine PA for clues
Questions for analyzing S/R:
- How many times has market touched the S/R?
- When market touched S/R, how does price action look?
- Are there any decisive breaks of S/R?
- If decisive breaks, has S/R zone flipped?
- What timeframe did S/R originate?
- What is the relevance of S/R vs your timeframe?
- Is there confluence?
Section#3: How to Trade S/R?
Answer 3 Questions:
- How do you enter?
- How do you exit if you’re wrong ?
- How do you exit if you’re correct?
- The process involves analyzing which S/R will hold up and which will break.
Section#4: How to Avoid Potential Pitfalls?
- Importance of having consistent framework for marking S/R. Without it, it’s easy to have hindsight bias
- Building consistent framework for S/R involves locking onto an objective method to define swing pivots
- Keep things simple. Resist the tendency to draw too many S/R levels. Identify appropriate zones, remove the rest
Conclusion- Support and Resistance:
- Start with market structure projections for S/R
- Keep things consistent- be systematic
- Keep things simple- not too many lines
- Practice with your chart- take your time
- Make notes of observations regarding S/R
- Integrate them into your trading strategy
