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In today’s episode, you’ll discover the truth about support and resistance which nobody tells you.
So tune in right now…
Resources
Support and Resistance Trading Strategy — The Advanced Guide
Descending Triangle Trading Strategy Guide
Transcript
Hey, hey, what’s up my friend?
In today’s episode, I want to share with you the truth about support and resistance that nobody tells you.
Here’s the thing…
It doesn’t matter whether you’re a swing trader, a day trader, a position trader, a counter-trend trader. Support resistance is one of the most commonly used tools in technical analysis. I find it’s important to really understand how this tool works.
What’s funny is that it’s very popular, but it’s pretty darn difficult to do a backtest on it because, let’s be honest, support and resistance are subjective.
What I’m about to share with you is based on my experience and years of trading support resistance, and based on my beliefs. But I could be wrong. So take the concepts and the idea I’m about to share with you to validate for yourself and find out if it’s true for you or not.
Let’s get started…
1. The more times support and resistance are tested within a short period of time, the weaker they become
For example, let’s talk about the shares of McDonald’s and huge institutions want to buy the 100 million shares of McDonald’s at $50. What’s gonna happen is that whenever price retest $50 at McDonald’s, out of this hundred million shares, a number of them are going to get filled.
Let’s say 50 million shares of McDonald’s get filled on the first test, then the price bounces higher, then it retests back to $50 again where 30 million shares get filled and the price rallies higher. Then the price came back after a few days and fill up the last remaining 20 million shares and bounces higher.
Now, imagine this, once all the hundred million shares are filled, and to keep things simple, no new order flow comes in when the price retest $50 once again, do you think there will be a bounce? Or will the $50 price level break?
Well, the price is likely to break. This is why the more times price tests a level within a short period of time, the weaker it becomes. Because order flow gets eaten up, and if no new order flow comes in, that’s where the level breakdown.
It doesn’t happen all the time, but generally, this is the case. This is why patterns like the ascending triangle is a bullish chart pattern. Because once all the selling pressure at resistance is used up, this is when the price makes a breakout.
Likewise for the descending triangle. The descending triangle is just the example of the McDonald’s one I’ve talked about earlier. Whenever price retest support, a bunch of order flow get filled. But if no new order flow comes in despite being retested multiple times, then the support area is likely to break down.
So that’s the first thing – the more times support and resistance are tested within a short period of time, the weaker it becomes. I know this goes against most textbooks that tell you, the more times support and resistance are being tested, the stronger it becomes.
But based on my experience, that’s not the case.
Moving on…
2. The longer the price is away from a level the more significant that level becomes
Let’s go back to the year 2000 after the dotcom bubble where NASDAQ approached near the $5,000 level and then it collapsed all the way down. It only revisited the $5,000 mark almost 20 years later.
Since the $5,000 level has held up for close to 20 years, it’s a significant level. If a level is significant, you want to be paying attention to it because a lot of traders will be watching the level.
For example, those who bought in 2000 near the $5,000 mark, they watched the asset price collapse for close to 20 years and only after 20 years then they see the price revisiting the highs.
So they feel a lot of pain. Imagine if you’re in the red for a good 20 years. That level becomes very significant. I’m not saying that the more significant is the more the reversal will occur because that’s not true.
Because if it breaks out of it, then you can imagine that the price will be trading at an all-time high, and there’s a good chance it’ll follow through higher.
But if you look through the charts of NASDAQ during the recent times when it retested the $5,000 level for the first time in close to 20 years, you’ll notice the price didn’t immediately breakout of $5,000.
It came into the $5,000 level and then it consolidated for a while because there was hesitation in the market. People know that this level in 2000 was an all-time high and are hesitant if the price will breakout higher.
That’s why the price consolidated for a good few weeks before it finally broke out of $5,000 into where it’s at now.
So the more longer the price is away from a level the more significant it becomes.
Next…
3. Support turned resistance and resistance turned support
When previous support is broken, it becomes resistance. When previous resistance is broken, it becomes support. There are a couple of reasons for this.
Let’s say the shares of Apple have resistance at $100. And their resistance has been in play for 5, 6 months but the price breaks out of resistance at $100 and it quickly moves up to $120, $130.
Traders who don’t want to miss the move again
There will be a group of traders who missed the move and regretted not buying at $100.
What they’ll do is they’ll place buy limit orders at $100 hoping the price retest $100 this time around and they can catch a piece of the move. That’s the first group of traders who place buying pressure at the $100 level.
Traders who want to get out of the red at breakeven
On the other hand, there’ll also be a group of traders who noticed the Apple shares always retests $100 and couldn’t breakout and they short sell at $100. Then the price broke out and they are in the red and losing money.
They’re feeling the pain and thinking, “Oh, man, I short at $100 but the price now is $120. I’m in the red. If only I could get out at breakeven, I’ll be contented.” Since they went short at $100 and want to get off the trade at the same price, they’ll place a buy limit order at that level to get out of the existing short trade.
With these two groups of traders: one group of traders who have a fear of missing out and the other who wants to get out at breakeven, these add buy limit orders or buying pressure at the $100 level.
That’s why you when the price breaks out of resistance, it tends to become support. Again, it doesn’t happen all the time, but it does happen more often than not.
And finally…
4. Support and resistance are areas on your chart
I know I use the word “lines” a few times, but really, they are an area on your chart. The reason is simple.
Let’s say we use an example from Coca Cola. Let’s say there’s a support of $70 for Coca Cola.
The anxious traders
And when the price reaches at $71, $72, there will be traders who are eager to buy because the price is almost approaching support and they’ll want to buy now in case the market doesn’t hit low enough before it makes a quick reversal.
These traders are too anxious to buy, so they’ll buy just slightly in front of support because they don’t want to miss the move.
The cheapskate traders
On the other hand, there’s another group of traders whom I call the cheapskate traders. They want to get the best possible price. For example, if let’s say support is $70, they will make queue smack at $69.90 to get the lowest absolute best price at support.
And here’s the thing…
In the markets you have no idea which group of traders is dominant, whether is it the anxious traders who can’t wait to enter a trade or is it the cheapskate trader who wants to get the best possible price.
So that’s why support is an area on your chart could be anywhere between $72 to $69. That’s your area of support. And this concept is the same as resistance. Don’t treat them as lines on your chart. They are not lines but rather an area on your chart.
Recap
- The more time support and resistance are tested within a short period of time, the weaker it becomes.
- The longer the price is away from a level the more significant the level becomes because there’s a lot of emotional baggage at that price point level.
- When support is broken, it tends to become resistance. When resistance is broken, it tends to become support.
- Support and resistance are areas on your chart.
With that said I’ve come towards the end of today’s episode. I wish you good luck and good trading. I’ll talk to you soon.