Support, Resistance and Trendlines

[Newtron Bomb]

FTSEBeater
I hope you dont mind but i took the liberty of cutting and pasting part of your thread so that questions can be directed more specifically to what people are concerned with.

I also thought that it would make it more organised to split the thread up in to bite sized portions like this for all the various topics like money management and position sizing, Patterns etc. etc.

Ok let's start with the basics of Support, Resistance and Trendlines. This really is the core basics of trading, and in my view is the foundation of a trading strategy. We will move onto indicators in time, but first

How Candlesticks are constructed.

There are 3 types of bars that can be used for charting. A line chart (which connects the closing prices), a bar chart and a candlestick chart.

A bar or candlestick chart will show the high, low, open and close for a set period (so on a daily chart, one bar represents one day). The high and low data is very important, so a line chart is no good for that.

There is no real difference between a bar or candlestick chart – they both show the same data so it’s personal preference – but I prefer to use candlesticks.

The above just shows how a bar or candle is created. The up candles have light or hollow "bodies", where as down candles have dark or filled "bodies"


Ok onto the technical stuff, Support, Resistance and Trendlines

Support:

Support is a level on a price chart, that price hits and finds a large amount of buyers, and hence the price starts to rise again

On the chart above of Cadbury’s you can see that every time price hit 399 / 400, it found enough buyers to force the price up.

Resistance:

Resistance is the level at which a price chart struggles to break above. When price hits a resistance level, the number of sellers is strong (as they know that the next move is down), and it takes a lot of buying pressure to get it above this level.

In the above chart you can see that there was a large number of sellers at 423, which was too strong for the buyers to push through.

Trendlines:

Trendlines are made by connecting 3 or more points along the same line. They either connect the tops of the highs together or the bottoms of the lows. Trendlines work because everyone sees them and know that the next time price hits that level, a reversal should happen, so they either rush to buy or sell depending if it is an uptrend or downtrend.

On this chart I have connected the highs together to create the straight line (or trendline). This is a downtrend because the trendline is pointing down (simple really)

On this chart I have connected the lows together, and as the lows are rising, it is in an uptrend.

….and that’s pretty much the foundation to trading. I know it sounds simple (and many of you would all ready know this), but it works and that is the main thing.


Ok, enough of me talking. Take a look at the chart for Anglo American, which has the symbol or ticker AAL.

We’ll look at the Daily chart (so every candle represents one day), and look at it over the last 6 months, and I would like you to draw in any support, resistance and trendlines you can see that you think are relevant. Remember there is no right or wrong to this.

For those of you who haven’t got a charting package, you can use the charts on www.advfn.com It’s free to sign up, and they do have a good service.

The link for the chart in advfn ishttp://www.advfn.com/cmn/chrt/chrt_...0&ind1_2=&ind2_2=&ind_type3=0&ind1_3=&ind2_3= To draw trendlines onto the chart you will need to load it up onto a charting package. To do this have a look at this link, which goes through and shows how to post charts onto Trade2Win. [url]http://www.trade2win.co.uk/boards/showthread.php?s=&threadid=4624[/url]
To draw the trendlines. Once the chart is on the paint package, you can draw lines and then save the image, complete with trendlines, ready to be posted.

It would be great if you could post a chart into this thread, and give some reasons why you’ve decided to draw the lines you did. To take it a step further, could you please write down what you would do based on the chart. So either buy now, sell now, stand to one side, buy at X price or sell at X price, and we’ll see how the chart progresses over the days and weeks to come.

Well that’s part one done, and I look forward to seeing your interpretation of the Anglo American chart.

 

[FTSE Beater]

Hi NB

No problem at all. It is a great idea, and hopefully makes things clearer

Thanks

 

[JTrader]

With trendlines I am presuming you always connect the bottoms in a rising trend and connect the tops in a falling trend and that you wouldn't ever connect the tops in a rising trend or connect the bottoms in a falling trend as then they wouldn't have anything to bounce off (I think I may have just answered the query that I was getting at). Is my understanding correct?

Cheers.

 

[Skimbleshanks]

One of the memorable things about Chris Manning was how he taught this - he said to imagine you were on an escalator; when you're going down all you see are the tops of heads, and when you're going up all you see are their bottoms!

So you're right.

However, sometimes it is also handy to put a parallel line in, to make a channel, and that can also help you visualise the trend.

 

[ChartMan]

In my opinion, channels are even more important than the support and resistance lines they are made from...

 

[reddragon]

Hi all,
Could somebody tell me if there is a "rule of thumb" as to
how many times the price needs to touch a support/resistance
line to confirm it as being solid, i.e 3/4 ??

 

[stevet]

reddragon

rememeber that you have to think in different time periods - so how many - ticks, 1 min, 5 min, etc through to years - and then just because it breaks does not mean that it has been broken - it just means the price has passed through that level -and then its next move could be a continuation or reversal - unfortunately when the "rules" were being made - someone forgot to tell the market!

 

[TBS]

Trendlines:

Trendlines are made by connecting 3 or more points along the same line. They either connect the tops of the highs together or the bottoms of the lows. Trendlines work because everyone sees them and know that the next time price hits that level, a reversal should happen, so they either rush to buy or sell depending if it is an uptrend or downtrend.

Same complaint as the lasttime this was posted - it is completely incorrect.

 

[Newtron Bomb]

Sorry Mark, but this is completely wrong.

A trendline requires two points (not three) the first point should be a reaction low if looking at a bull trend or a reaction high if looking at a bear trend.

The second point is ideally a second reaction high or low, but not necessarily, it may also be a level of support or resistance.

This is used particularly on breakouts, when the price charges up (or down) at an unprecidented and unsustainable rate (and thus is more likely to retrace than anything else). In this situation the trendline is linked from the high or low to a point along the broken support or resistance level, in line with the price action. The reamina like this until a second more established point is made.

Trendlines do not 'work' because 'everyone sees them', I've never read such rubbish!

They are an ever-changing level of support or resistance, points at which the buying pressure or selling pressure is sufficient to hold the price action - giving you your next points in the trend, not the other way around.

 

[TBS]

Hi NB,

You may as well have the full reply that FB decided shouldn't sit in his incorrect thread:


Hi Mark,

I’ll use your chart to explain why I think that your initial statements about trend are wrong. First though let’s have a look at what trends are about and then use your chart to explain how to use them.

A trend is an ever-changing level of support or resistance. It changes in several ways:

1. As time progresses, the level at which a trend is broken changes (if it didn’t it would be a horizontal line)
2. Trend lines have to be appropriate to the type of trader you are and, more importantly, the time frame that you operate over.
3. Trend lines interact with support and resistance, in effect, the convergence of a trend, support, resistance and the price action determines entry and exit points.
4. The breaking of a trend line is NOT a signal to enter a trade and it is not always a signal to exit a trade, that depends on the trader (more in the examples).
5. The more times a trend is tested and holds, the more significant it is.

Before looking at the charts a couple of points abut support and resistance:

1. Support is a level at which there is sufficient buying interest to halt the decline in the price action and cause it to reverse and move upwards.
2. Resistance is a level at which there is sufficient selling interest to halt the rise in the price action causing it to reverse and move downwards.
3. Support and resistance levels become more important the more times they are hit and hold.
4. The breaks of support and resistance are the most common entry signals.

Now a look at your chart and some ways of trading the main trends in that chart:

This is the start point of your chart – we don’t know what the previous history was, but this gives us a start point. A fairly hard bear trend dropping down with the nearby support and resistance marked. At this point I would rather be short than long, although if this was my first view of the chart and I was looking for an entry into the market, my entry would be a close below the current support level.

Now the chart gets more interesting, firstly the trend is broken – decision time for traders.

1. If I am already short in the market, do I close the position on the break of trend? – This depends on what type of trader you are. If you are ‘specialising in this stock’ or sitting on a large profit – some of which you are prepared to forego – then you may continue to be short, waiting to see if the overhead resistance holds and the priceaction continues to drop.
2. If I am already short in the market, but am a purely technical trader that moves from stock to stock, I would close the position with a view to re-entering if the support level is broken.
3. If I am not in the market, but looking for an entry point, this now causes some interest and the closing break of overhead resistance becomes an entry point, with the idea of using a break below the support as a signal to get out again.

Also in this portion of chart we see the overhead resistance broken. This is a clear buy signal. Those traders that have not closed their positions should do so, and go long. Those waiting on the sidelines should also enter the market. At this point we can draw in the start of the new bull trend, using the first reaction low. We now have a bull market with immediate support and base support.

Throughout October we see the price rise steadily until we get to the point where the price action cuts through the trend.

Again it is decision time – close or let it run? – The same arguments apply, we look for the immediate support and resistance levels, according to your time frame you may decide to close and move on elsewhere, or to hold until that base support level is breached – a personal decision. As it is we now have a stock that is moving sideways, out of trend (neutral) with definite support and resistance levels.

The price action breaks back above the previous resistance, allowing us to move the trend line across to encompass the small range that had formed, we swing from neutral, to bull, back to neutral again. Throughout this period of the price action, the base support becomes stronger and with each subsequent price action move, the trend line can be legitimately widened along the support level to encompass the price action. This period of time would probably be a nightmare for a pure TA flitting in and out of the stock.

The price action breaks back out of the range again and e continue to rise until we get to the point where the price action is back onto the trendline and hovering just above the immediate support with firmly established resistance at the top of the chart.

An important phase for this chart. The price action actually moves straight from bull to bear, not even waiting for a period of neutrality – this shows that the market view is now particularly weak towards this stock (perhaps poor results etc.) This is a clear Sell signal

We can also see how the ‘Oooh it’s cheap’ mob move in and push the price back up to retest the previous support, which now acts as resistance (Dead Man’s Knock) – which is also a classic entry point for TA traders. On the close below the support level we can also draw in the new bear trend. We also have a level of support formed around the level of previous resistance.

The pause around the support level continued, creating a pretty firm level of support – however, all this action continued to happen under the bear trend, threatening it at one point, but falling back – allowing us to widen the trend slightly, ensuring that we encompass all the price action. The overhead resistance continues to be unthreatened. At the end of this view, we see the price action break through the support. This also completes the break of the neckline of a head and shoulder reversal with a target somewhere near the base support of the last 6 months.

Finally:

This final chart shows where we are now, still under a bear trend, still looking for the target for the H&S reversal, the previous levels of support and resistance continue to play their part in forming the price action and controlling the trend. Unsurprisingly the recent action bounced off 100 – probably the ultimate psychological support/resistance level in many UK stocks. Personally I wouldn’t be surprised to see to break down to new lows – but that is just a TA opinion based around the H&S reversal. Whatever, if I was interested in trading this stock (which I am not) then I would be ready to take the appropriate action on breaks of trend and support/resistance – my ‘opinions’ mean bugger all, the chart will tell me what to do and when, all I have to do is make sure I have my trade plan ready to go for whatever eventualities are important to me.

So back to my original problems with your first post, trendlines do not need three points, in an ideal world, we would love to have three points, the more the merrier – and the stronger and more prolonged the trend would become.

Also the thought that ‘everyone buys (or sells)’ because of that trend line, is wholly wrong, the trend line is a function of the interaction of support and resistance levels and it can be broken through periods of neutrality then moved to encompass that price action should it continue to move in the previous direction.

Trend lines are fluid, not set in stone, how you trade around this depends on your own trading style and trade plan.

Oh, and you don’t need that much drugs or alcohol to spot the head and shoulders, not that it is necessary, other than to provide some sort of target for the price action – at the end of the day the trend, support and resistance tell the story.

 

[barjon]

good stuff TBS

 

[barjon]

TBS

I forgot to add that FTSEBeater is right as well.

A preliminary trend line is drawn between two points
but it must be touched for a third time to make it a
valid trendline

good trading

jon

 

[TBS]

Hi Jon,

Sorry can't let this one go as it is such an important basic building block!

From FB:

Trendlines are made by connecting 3 or more points along the same line. They either connect the tops of the highs together or the bottoms of the lows. Trendlines work because everyone sees them and know that the next time price hits that level, a reversal should happen, so they either rush to buy or sell depending if it is an uptrend or downtrend.

A trendline is a trendline, it needs at least one reaction low/high and a second level of support or resistance - ideally a second reaction low/high. If we get a third - fourth etc.. then great as you say it validates the trendline, but they are not a requirement.

The last part 'Trendlines work because.......' is fantasyland.

Don't get me wrong, I think most of Mark's original thread is great, well written and very useful to 'newbies', but this essential part about trendlines is wholly wrong - sorry to bang on about it!

 

[Trader333]

TBS,

How have you been able to post multiple image files in the same post as I was not aware you could ?


Paul

 

[barjon]

TBS

don't want to get into an argument but a classic trendline
does require a successful test (the third point). To quote
from Murphy:

An up trendline is drawn by connecting two reaction lows
with the second low higher than the first. So far, all we have
is a tentative trendline. In order to confirm the validity of a
trendline, however, that line should be touched a third time
with prices bouncing off it. To summarise, two points are
needed to draw the trendline and a third point to make it a
valid trendline

That is not to deny the usefulness of tentative trendlines -
as you have so amply demonstrated.

I agree that trendlines "work" because of the interaction of
support & resistance (supply and demand). Of course, changes
in the supply and demand balance may be triggered in part
by technical traders who enter a trade because we have
arrived at a trendline.

No-one is ever 100% right or wrong in this game!!

good trading

jon

 

[neil]

Barjon

Take a look at how Vic Sperandeo draws trendlines - from lowest low to low preceding the highest high. A break of this trendline usually results in what TBS has drawn - a consolidation comprising of a support and resistance.

When this consolidation/support/res. is broken then the trend line moves to incorporate the next low preceding the highest high.

Sperandeo uses terms like a "1- 2 -3" break out where the trend can eventually reverse out of the Consolidation breaking either support or res as it does so.

rather like TBS's example price action is king with trendlines resulting from breaks of consolidation /supp or res.

You will often see these "trendlines" having to be re-drawn maybe two or three times as the momentum of the move increases or wanes, culminating in a new consolidation and change of trend.

I may not have explained the above very well but it's in Sperandeo's book "Methods of a wall street master" or some such title.

 

[stevet]

trend lines always work for technical analysts, since they are not traders, and therefore not the ones whose bucks are being chewed up by hitting stops by the noise around the trend line

 

[TBS]

trend lines always work for technical analysts, since they are not traders, and therefore not the ones whose bucks are being chewed up by hitting stops by the noise around the trend line

Don't be a twat all your life, take a day off.

 

[barjon]

neil

yes - I'd term these active trendlines which are a bit
different from classic trendlines. I added my piece because
this is a first steps board and I thought newcomers might
be getting a bit confused.

jon

 

[stevet]

Mr TBS - i dont lke being insulted - remember that