NOVICE TRADER
Identifying Crucial Support And Resistance Levels
by Ned Gandevani
One tenet of technical analysis is the concept of support and resistance.
In it, markets stop declining, thereby establishing a support level. A
resistance level is set when a rally completes its rise. Some support and
resistance levels may be more important than others. Here's a way to determine
the key levels.
A look at market movement tells us that price
fluctuates between a level of support and a level of resistance. Recognizing
key support and resistance levels can improve our ability to enter, exit,
and manage our trades. So how can we determine which support and resistance
levels are the most important? Looking at an intraday S&P price chart,
we find a multitude of such levels -- and the market pays respect to some,
while it completely ignores others.
FIGURE 1: FLOW CHART. Here are the steps to identify
common numbers for the market of your choice.
Many different approaches are used to identify support and resistance levels
in the market, but a great number of them are unreliable. These approaches
include but are not limited to some methodologies that utilize Fibonacci
numbers and ratios, trendlines, moving averages, and Gann concepts. Those
techniques have a static view of the market. Those approaches assume that
the market will repeat past behavior and experience and can therefore be
viewed linearly. They also use fixed intervals for inputs, which creates
yet another problem.
The market is not a static phenomenon. We cannot expect the market
to disregard all the changes of economic and industrial macroforces that
exert pressure on price movements. The market is most certainly a complex
and dynamic phenomenon, but it is clear that price fluctuates between levels
of support and resistance. How can we identify these levels in advance?
THE PSYCHOLOGY
First, let's review the psychological concept of support and resistance
in the market. What does support and resistance mean and how are they significant
to price movement? Support is a price level that indicates a temporary
fair value of a tradable for the market. Prior to that level, sellers sell
the market because they view it as overpriced. The market is pushed down
to a level at which buyers step in with more money to hold price at the
new level.
At that time, both sellers and buyers have made a decision regarding
the market valuation based on their individual systems of valuation. If
the buyers perceive this new level to be a good price for the market, they
could flood the market with more buying pressure to hold the new level
and eventually cause the price to rise. In the case of resistance, buyers
keep pushing price higher with buying pressure because of the good opportunity.
At perceived excessively high price levels, however, sellers enter the
market looking for the opportunity to sell at inflated prices with higher
volume, therefore creating resistance.
With this understanding of the basics of support and resistance, it
seems logical we should contact all of the available market participants,
survey their opinions regarding fair pricing, and then establish price
values of support and resistance. This is, clearly, unrealistic. However,
representation for all market participants would give us a clue as to the
common levels of support and resistance -- levels common to all participants.
Ned Gandevani developed the Winning Edge S&P day
trading methodology, a nonmechanical trading method based on chaos theory.
For more information, visit his Website at www.winningedgesystem.com or
E-mail him at Gandevani@worldnet.att.net.
Excerpted from an article originally published in the July 1999 issue
of Technical Analysis of STOCKS & COMMODITIES
magazine. All rights reserved. © Copyright 1999, Technical
Analysis, Inc.
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