The Essentials of Trading

Information and resources to learn about trading and the markets

How do I decide which support and resistance levels are significant?

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Here’s a trader question on the subject of support and resistance.

I am having trouble deciding where to draw support and resistance lines on a one day forex chart. To me it seems that you could go to extremes and draw support / resistance lines from every fractal. How do I decide which s/r levels are significant?

Support and Resistance is definitely a topic a lot of traders struggle with – and not just new ones.

Technical analysts and traders will throw out  a lot of different things they say tell you what you should be looking at. They include highs and lows. They include moving average lines. They include Fibonacci and other projection/retracement levels. While it’s definitely true that if the market is focused on something as a key level, then it becomes a key level – a self-fullfilling prophecy.

Most of that stuff is really nothing more than a line on a chart, though. I personally prefer to look at where the markets have rejected prices, and also the attraction points because they absolutely play into the whole mix.

A little while back, I recorded a video highlighting the way I look at support and resistance to describe what you should have in mind what you’re really looking for to spot those levels. Check it out. I think it could really open your eyes.

Can you tell me where I can find free forex charts?

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Here’s a pretty straightforward question I received from a forex trader over the weekend.
I couldn’t find a free charting service for forex. Can you enlighten me. I only trade forex.
Thanks,
Wayne
The first thing I would say on this subject is that the vast majority of retail forex brokers these days offer free charting as part of their trading platforms. Most of them are pretty useful. Obviously, some are better than others, or have features which some traders like more than others.
The one frustration for me has been the fact that many of these platforms will only go up to daily charts. I happen to do quite a bit of position oriented trading, so I want weekly charts – and sometimes monthly.
Something a lot of traders use if they are unhappy with the charts their broker provides (or they don’t get any at all) is MetaTrader. This is a charting, system, and trading platform that can be linked in for direct (even automatic) trading through a number of brokers. I do not myself use MetaTrader because I simply don’t need it.A great many folks do, however. (Note: This is not related at all to MetaStock)
If you use another free charting package (or want to share your thoughts on MT), feel free to leave a comment.

Track Market Volatility to Improve Trading Performance

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Over the weekend Brett Steenbarger posted The Psychology of Market Volatility to his blog. He makes some very interesting observations about the way traders react to changes in volatility – or fail to do, more like.

I would be willing to bet that a great deal of the troubles traders have in sustaining consistent performance has to do with changing volatility. Markets change. They go through periods of high volatility, periods of low volatility, and those in between. And it happens in all different timescales. Some traders have strategies which work well in one environment and poorly in others. This is why there were some ringing the death knell of technical analysis in the first quarter of this year. Volatility had changed, dramatically altering the effectiveness of methods traders use.

The varying volatility landscape is a major part of why I have never been an advocate of fixed sized stops. A stop of a certain size will have different chances of being hit under different volatility conditions. If you use the same size stop all the time, you will take more losses in high volatility periods and you will probably end up trading too small in the low volatility spells.

All of this is why you need to be conscious of what the market is doing. Volatility shows persistence. That means markets at low volatilities tend to stay that way, and the same with high volatility markets. Of course there will be transitions, but normally you can see that if you’re paying attention to things like the width of the Bollinger Bands or the Average True Range indicator.

How Do I Know When to Enter a Trade?

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The following question came in yesterday concerning support & resistance and trade entries.

I am fairly new to trading, I’ve been trying to trade the dow e-mini on a 5 minute chart. I seem to fairly accurate support & resistance lines (not made by me) but how do I know exactly when to enter the trade? when the time comes say when it is approaching  support, when do  I enter a long position or know that it may keep going thru support  and be a breakdown? Is it something to do with where the bar closes and the next opens?

This is, of course, the major question for those using support and resistance based strategies. The general idea is to fade moves to those critical levels, but sometimes the market just goes blowing through with hardly a pause. When it’s in our favor it’s fantastic, but when it’s against us it’s extremely frustrating.

I myself use a strategy based heavily on support and resistance, so I can appreciate this question. There are a couple of things that can help this be the most successful.

First, trade only with the dominant market direction. That means if the market is showing strength, take the long trades, but avoid the short ones. That puts the power of the market in your favor. Going against it not only increases the chances for taking a loss, but also probably reduces the gains you would make when trades were profitable.

Secondly, look for fading momentum as your indication that a support or resistance level will hold. I work in the stock market, so I watch to see if the internals are getting better in the direction of the move, or starting to slack off. That can be a great indication whether the market is going to punch through expected support or resistance, or whether it’s going to check up. Using the action in a shorter-term timeframe can help indentifying fading momentum too.

Those are the two things I do to improve my chances for success trading support & resistance levels. I’m sure others have thoughts of their own.