Support and resistance - total rot ?

[meanreversion]

The title is meant to be get people interested.

Why do the concepts of "support" and "resistance" seem to work - is this because they are self-fulfilling, i.e. most people see the level and react in a similar way? Or is there something else going on?

 

[robster970]

Value traders use prices to define whether a security is under or over valued. If there is sufficient volume transacted by the value traders at a certain level, momentum traders then see this, join the party and push the price away creating the perception of support/resistance.

So it is a self-fulfilling prophecy IMO.

 

[Konviction]

Because history repeats itself. Look at this chart of RIMM. Most traders, unless they have a darn good reason wont be looking to buy near 76..why?..because thats where price tops out at before heading down. 56 is a much better price. Its more complex than that, but generally speaking.

http://stockcharts.com/h-sc/ui?s=RIMM&p=D&yr=0&mn=10&dy=0&id=p87865332918

 

[pboyles]

- is this because they are self-fulfilling, i.e. most people see the level and react in a similar way??

yes

 

[Rossini]

You phrase this part of the question in an odd way ''seems to work''. What seems to work exactly? The fact that prices can bounce off the same level twice or more? Does that mean ''its working?'' Or could that just be coincidence? S&R is just like almost anything else: Its the perception and interpretation that matters, so S&R doesn't ''work'' but your interpretation of it might.

Look at it from another way: Support and resistance hold the same number of times than they break. So one could easily argue that S&R ''doesn't seem to work'' would this be true?

Like you, im just trying to provoke an interesting debate ;-)

 

[DionysusToast]

I think the answer is "it depends". If someone has a large buy order to fill at a price point, then that will effectively act as support. So - in this case, over a relatively short period, the support will be definite and unsurmountable until those orders are filled.

If you consider a longer time frame, and an accumulation scenario. It's a different story. If the supply of stocks on the market has been constrained, then there is absolutely no reason to think there will be enough supply at a point of resistance to stop the up move that occurs as a result of the accumulation.

There are those that will say support and resistance works the same across all markets and all timeframes and in all circumstances. This is ludicrous. The fact is, if Steve Jobs died tomorrow, would we expect prior support on AAPL to hold ? If a stock with a million share float issued another 100 million shares, would we expect any prior support and resistance to be valid ? Of course not.

Anything you look at needs to be taken in context.

 

[wackypete2]

Anything you look at needs to be taken in context.

True. If you don't understand it then nothing will work for you.

Peter

 

[who_am_i]

I think like anything else, S&R is a great guideline to follow, but there are always exceptions in situations. I know of traders that use nothing but S&R when they trade and do quite well.

 

[meanreversion]

You phrase this part of the question in an odd way ''seems to work''. What seems to work exactly? The fact that prices can bounce off the same level twice or more? Does that mean ''its working?'' Or could that just be coincidence? S&R is just like almost anything else: Its the perception and interpretation that matters, so S&R doesn't ''work'' but your interpretation of it might.

Look at it from another way: Support and resistance hold the same number of times than they break. So one could easily argue that S&R ''doesn't seem to work'' would this be true?

Like you, im just trying to provoke an interesting debate ;-)

That's an excellent reply and it takes the discussion to a philosophical level. I personally do not use S&R in my trading, but the acceptance of its existence is universal and the question is why. But using your logic (which is faultless I think), this would be akin to asking "does the 38% Fibonacci retracement exist"? Well it does to SOMEONE, but it might not to you. Doesn't mean it can't be useful.

Support and resistance exist in the minds of sufficient people that it can sometimes be self fulfilling, and thus it's important to those who use it. But similarly there will be breakout traders looking for the exact same levels breaching to initiate further movement ----- is that a better way to summarise?

Good thread so far, I like it.

 

[timsk]

If there is sufficient volume transacted by the value traders at a certain level, momentum traders then see this, join the party and push the price away creating the perception of support/resistance.

Hi robster,
I don't quite agree with you. New traders 'joining the party' aren't, generally, the ones responsible for momentum in a price move, IMO. My view is that the momentum that's sometimes created either side of S&R is - usually - a consequence of traders with open positions closing them to book profits or to minimise loss, as opposed to new traders coming into the market. Take two scenarios:

A.In a rising market, price hits resistance and holds.
Anyone long will be looking to bail as resistance looks to be holding. Some new traders will - of course - enter with short positions. However, if price pulls back any distance and with momentum - this is mainly a consequence of the longs closing their positions, rather than traders opening new short positions. Why? Because long holders are the larger dominant group and it's their numbers that will create in imbalance in supply/demand sufficient to cause price to fall with momentum as they take what profits they can before price gets back down to their entry level.

B.In a rising market, price hits resistance and fails.
Unlike scenario A, the longs from lower levels will - for the most part - hold their positions and let their winners run. The speculative shorts who expected resistance to hold will - for the most part - have stops just above the resistance level. As these tend to be clustered within a tight zone, price will suddenly 'pop' as they are all taken out together. However, these - and any new longs buying the breakout (or existing holders adding to their positions) tend not to be sufficient to carry price a lot higher and certainly not with momentum. There's unlikely to be enough of them. For that to happen, traders who entered shorts at much higher levels (assuming there are some) will need to be threatened and start to unwind their positions. It's their actions that will create a huge imbalance in supply/demand sufficient to cause price to rise with momentum as they take what profits they can before price gets back up to their entry level.

In scenario B, having breached resistance, price could be in blue sky territory making fresh highs at levels where there are no existing short holders. In these circumstances, if price moves higher with momentum, then this can only be as a result of fresh longs desperately jumping on board the starship hoping to catch a ride to the heavens. I would stress these are generalisations and not absolutes. However, as generalisations go, IMO, momentum is usually a result of the actions of those who have the most to lose, rather than by those who have something to gain.
Tim.

 

[scose-no-doubt]

My take on S&R... The market is used by many entities for practical rather than speculative purposes. These will know the market inside out and will probabaly have deep insight into how the markets price info in. Some people simply will not buy at a certain levels (hence holding reserves/inventories as the case may be) just as wholesalers will not sell at certain level. These past levels will obviously be considered by these entities just as me and you would consider how much we paid for potatoes in the shop last week but obv more there is more price volatility in the markets. The price action from these players is what drives the speculative opinion which leads to PA that most of us know and follow. As the underlying economic condition changes (E.G rates, news) the PA/SR etc becomes less important and basic supply and demand fundamentals come into play as the big buyers/sellers attempt to renegotiate a fair price or range.

 

[robster970]

Hi robster,
I don't quite agree with you.

You're not disagreeing with me per se. You're disagreeing with Larry Harris, Professor of Economics and previously the Chief Economist at the SEC.

When resistance works, the value traders have deemed the security over-valued. There is usually a liquidity imbalance at this point (shortage of sellers) and the value traders become liquidity suppliers. The herd then follows and then prices go down again.

When resistance fails, it's because no value traders have been active at that level and the trend continues because they don't think the security is over-valued. There is no liquidity imbalance at this point and trend carries on (no shortage of sellers)

Of course the reverse is true for support.

Think about S/R in terms of liquidity and how value traders provide a liquidity service to the market when there is an imbalance.

 

[scose-no-doubt]

After reading rob spost I realise I should have read the whole thread lol.

 

[robster970]

After reading rob spost I realise I should have read the whole thread lol.

I thought your answer was bang on LOL

 

[scose-no-doubt]

Yours is more articulate and uses proper terminology

 

[meanreversion]

So what's the conclusion.. S&R clearly exist and affect the decisions of a meaningful number of traders, so it's self-fulfulling?

 

[timsk]

You're not disagreeing with me per se. You're disagreeing with Larry Harris, Professor of Economics and previously the Chief Economist at the SEC.

Phew! That's fine; I've no issues whatsoever disagreeing with boffins with letters after their name - but have never actually traded in their lives (probably). It's disagreeing with real traders who know and understand the markets much better than me that makes me nervous!

 

[Rossini]

lol Tim.

 

[bbmac]

Interesting discussion so far....By way of example the screenshot below is how I see the near-term 1hr gbpusd chart in respect of potential support/resistance factors...As you will see the shaded areas represent the most obvious near-term imbalances of supply/demand and demand/supply and the blue/maroon shaded areas are where those obvious near-term previous swing lo/hi's on this t/f and co-existant with such on the higher 4hr t/f...These previous near-term imbalances of supp/dem or dem/supp represented by the most obvious prev near-term swing hi/lo's on any t/f are what actually happened in the market and it is price action's beahvious around them that give clues as to whether they will hold or break...(indicators too can add confluence to any decision made at such areas re trading opportunities, such as momentum's divergence from price and change in volatility and volume) The fibs and trend lines are more self-fulfilling but can also be a useful addition in respect of confluence of tech factors in making trading decsions around such areas.

 

[scose-no-doubt]

Phew! That's fine; I've no issues whatsoever disagreeing with boffins with letters after their name - but have never actually traded in their lives (probably).

I hate when people say things like this. It's daft to even consider that this man has never or doesn't trade in some form.