Support and resistance. As previously discussed, I strongly believe that a price chart is a graphical representation of human behavior and market sentiment. The many thousands of traders and investors that interact in a given market come together to create a *collwective conciousness*, if you will. This is evident at how the market *remembers* significant price levels which may have acted as S/R in the past. The multitudes of traders will collectively recognize these price levels, which may cause a reaction or reversal in price movement. To be able to recognise significant areas of support and resistance can present important technical information and offer good trading opportunities.
There are many methods used to identify support and resistance. Simple counting identical high/low hits, trendlines, prior swing highs and lows, natural retracements, fib projections, moving averages, pivot points, and so forth. Individually, these techniques can be useful when combined with trend analysis and patterns… but these methods are much more reliable when used in conjuction with each other. This is how I use these techniques to be able to project strong levels of support and resistance to project potential turning points and reversals.
Do not underestimate the power of support and resistance. Used properly, it can allow aggressive traders to add an element of precision in their trading with much smaller risk. For the conservative trader, at the very least, it can allow one to anticipate a reversal and give confident to an entry signal.
(4) Price patterns. The market constantly displays habitual patterns of behavior that occur frequently. This tendency of the market, IMO, completely invalidates the *efficient market theory*. That theory states that all price movement is random, and that ultimately supply and demand factors will prevail, whereby the value of a product will achieve a state of equilibrium that reflects its true value. Well, in my years as a trader and investor, it has become very clear that the markets are anything but efficient.
Fear and greed are always dominating the markets. The thoughts and feelings behind any dominant consensus shared by market participants will almost always create an extreme in price action. In the long term, trends are created in this manner. Trend analysis can be used to determine dominant consensus, cycles and S/R can be used to anticipate and project turning points (both with and against the direction of the trend).
Price patterns can be used to recognize and confirm a swing or reversal, as well as to generate entry and exit signals. Price patterns top and bottoms, pennants, channels, head and shoulders etc. can help in determining a directional bias when prices break from the formation.
Price action analysis, which is an analysis of a single trading day, or 2 to 3 days, can also be used to anticipate market direction and for entry signals (known as pattern entries). A key reversal, outside day or insidec day are good examples. On their own, they have limited efficiency. But when used in combination with the other concepts such as trend, support/resistance and cycles, they increase their reliability and become very useful tools.
What is significant about price patterns, is that they usually provide a process of confirmation… whereby we have some indication of the market starting to move in the direction of our analysis, forecast or bias… prior to trade entry. Thus, the probabilities of a profitable trade increase.
It is important to understand that human behavior drives the markets… and any indicators that you use should be used in this light.I hope it is becoming obvious how important it is to acquire a solid knowledge base in the field of trading.
Becoming familiar with the factors that influence price movements, as well as the importance of trading a method or system and planning all aspects of trading is very important. Trend analysisy cycles and retracements, support and resistance, and price patterns are areas of research that may benefit the new trader.
Up till now I have concentrated on the tangible, technical aspects of trading. However, trading involves many other intangible factors that are frequently overlooked… and which may well be the most important elements to determine the long term success of a trader.
For continuation, see part six of this rather long original article.