Support and Resistance Trading
What is Support and Resistance Levels in
Stock Trading?
Support and resistance are specific
price areas or price levels which either support prices on
declines in up trends or which resist prices on rallies in down
trends.
In an up trend, short term and day traders will attempt to buy
at support or at levels of support. In a down trend, short term
and day traders will attempt to sell at resistance levels or in
resistance areas.
If support and resistance levels cannot be determined, then
you cannot define concise levels in which to establish entry or
exit positions in your specific trade. It is of utmost
importance for traders to develop effective strategies and
methodologies for calculating support and resistance levels.
These levels can be determined with the use of various trading
tools like Point and Figure charts, Fibonacci numbers and Gann
angles.
Day traders is in a definite advantage when it comes to the
use of support and resistance levels, in as much that the day
trader’s trade normally end when the trading day is over and if
a bad trade or decision was made based on support or resistance
levels it will not be repeated in the next trading day.
Determining support and resistance levels are somewhat
different for the day trader than the position trader. This is
because support and resistance levels for the day trader must
be closer to the current market price that they are for the
long term or position trader. Markets can only drop so far in
one day, and consequently the determination of support and
resistance levels by the day trader must be realistic in terms
of what can be expected – however this does mean that day
traders must be willing to use realistic technical support and
resistance levels in order to establish their positions.
The following method may appear very simple, yet it is
enormously effective at isolating support and resistance levels
and can be applied profitably in any market:
1. Follow a 3-day moving average of
the highs, and a 3-day simple moving average of the lows.
2. Take the 3-day moving average of the
highs to act as your resistance level, and the 3-day moving
average of the lows to act as your support level.
3. Add a filter by drawing in the support
of the lows if the trade has made a 3-day high in say, the last
3 days (you can use four or five days, depending on your
trading methodology) This means that you will only draw in the
3-day moving average of the highs if the stock has made a 3-day
low in the last three days – this means that you only want to
sell when the short term is down.
In summary you can apply this trading rule of thumb in a
paper trading exercise;
- Find and draw all your levels of support and
resistance.
- Draw all your trendlines - This will help you to create
a "bias" and also determine if the stock you are
following are in a up or downtrend.
- Decide if the trend is bullish or bearish.
- If you decide the trend is bullish, place
your stop loss at the last low. Look at your
anticipated risk and potential financial loss - If you
decide that you cannot afford the loss, stay out of the
trade.
- If you decide the trend is bearish, place your stop
loss at the last high. Look at your anticipated risk and
potential financial loss - If you cannot afford the
loss, stay out of the trade.
- Remember to trade according to your trading plan.
This is a very simple method of trading stocks/commodities
with support and resistance on a daily basis, and if calculated
correctly they will work.
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