On Market types and the Tools of the Trade IV, we will discuss Levels, breakouts, support and resistance.
The fight of beliefs
I’ll tell you here my personal view about levels, support, resistance and breakouts. People trade their beliefs about the markets. Price is constantly moving in a struggle of two sides, while a third side is watching.
The fight is between those who believe it’ll go up and those believing it’s already too high and must go down. If there are fewer believers on one side than on the other side, then price moves against them. Until a new consensus arises, both parties with similar power.
Support and resistance
When the power of bulls and bears is similar, the price cannot move up or down any longer. Until one of the parties weaken or the other gets more strength price moves inside a tight range. In the case of a price going up and, then stagnating, that price region is called resistance. When the price moves downward and at some point stops making new lows it’s called support.
Breakouts
When the price is pushed beyond resistance or down a support level is called a breakout. Sometimes the breakout does not hold, the price returning to its previous levels after a few bars. In such cases, it’s called a failed breakout. Thus, the passing of time confirms the breakout. As time goes, the strength of a support or resistance level grows.
A practical example
Fig 1 shows a couple of support and resistance channels with two breakouts. As we can see, the support line on the second triangular formation is the salmon-coloured line touching the peak of the previous channel. This is quite usual, and a persistent pattern in trading charts. Current support levels were previous resistance levels trespassed on a price breakout. Similarly, current resistance levels were old supports that had been violated.
Support and resistance patterns are extraordinarily useful. This is due to its rather good predictive value. Buying at support and selling at resistance is one of the better strategies around. And not only by its success rate but, also, because they are places with excellent reward to risk ratio.
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