Use This Futures Trader’s Trick to Reveal Hidden Support and Resistance Levels
I’m right in the middle of writing a new beginner’s guide to Forex trading…
You’ll be invited to see it all in full very soon but I thought I’d share the key concepts from one particular section with you today.
I want to show you the way I was taught to think about support and resistance.
It’s a very commonly used concept in Forex trading but I think it’s often oversimplified. And by using a quick trick I’m positive you can open up a whole new treasure-trove of opportunities for yourself.
If you do this right it can be a powerful tool. You just need use it in a way that creates a profitable edge. Expect a mix of winning and losing opportunities of course, that’s the reality of all robust strategies. But if you plot S&R levels accurately they can offer you three big advantages.
Three Advantages of Accurate Support and Resistance levels
- They can help you find strong reversal points in the market. These can be full-blown changes in trend or continuation signals that let you rejoin the current trend
- They can help you find explosive breakout trades. If you know where the support and resistance is, you can calculate the point at which it becomes broken. You can often jump onboard just as powerful directional moves are getting underway
- You can use S&R to confirm other trading signals. Being aware of S&R areas can help you filter out low-probability trades. Your knowledge can help stop you entering short trades when the market is hovering right above a big support level. You can also take extra confidence in signals from your other systems and strategies that coincide with S&R levels.
So like I said earlier, it all often gets oversimplified with Forex. I don’t think it’s a case of traders being deliberately misled, but the little nuances – the market activity that can give you an edge – often get overlooked.
The reason why?
It all comes down to volume traded.
Futures traders view support and resistance (S&R) differently to your average Forex trader because they have an accurate reading of the volume traded at each price. This can help uncover true areas the market is looking to for S&R.
The more volume traded inside a band of pricing – the more significant to the market that area is.
It’s not a case of guessing, the market is showing you. The players are voting with their feet.
The difficulty with this approach in the Forex markets is there is no definitive volume count. It’s an over-the-counter market so there’s no central record. The volume stats you’ll see offered are often a count of the number of transactions rather than the actual sum of monies that are changing hands.
But don’t worry!
With a little bit of creative thinking I’ll show you how you can still find good levels to use. But first, let’s take a look at the common way many Forex books look at support and resistance.
The Common Approach to Support and Resistance
Here’s a 60 minute chart of GBPUSD that we’ll use to look at some examples:
Now the common way traders approach this is to simply label up any intermediate lows as support, and intermediate highs as resistance.
So on this chart, as soon as that spike low printed at point (A) a horizontal line might get drawn on the chart and the trader waits for the market to retest those lows. He’d look for signs of a reversal as the market moved back down there.
A day or so later the market does take a dip. It doesn’t get down as low as point (A) but it does put in a new intermediate low at point (B).
“Oh well” the trader thinks. “I’ll put in a new line at point (B) and treat the area in between the two lines as support”.
But let’s have a think about what’s actually going on here…
How to Find Accurate S&R Levels
When the market recoiled upwards at point (A) there was certainly a reason the buyers aggressively stepped in. But where do you think the bulk of the buying actually happened, right at the tip of that spike low?
If you could see an accurate cross-section of the volume traded it would probably look more like this:
It’s a classic bell-shaped curve. The bulk of the buying is accumulated around the price the big buyers were interested in.
But we also get a kind of elastic-band overstretch effect (the long-tail that stretches down to the very low point of the red bar). It’s because the downside momentum must slow down and grind to a halt before the market can ping back up again.
Think of it like this… you’re driving your car along at 30 miles an hour and you want to try and stop it right on top of the line at a set of traffic lights. The only thing is you’re not allowed to press the brake pedal until you’re already above the line.
You’d expect the car to overshoot a bit wouldn’t you? You’d need to allow a bit of time for the forward momentum to stop. Well it’s the same when the market reaches a key price level. You need to allow for a bit of overshoot.
Once the market has moved back to the upside we can then use the bell-shaped curve idea to find a future level of support. We can get a good idea of the price level the big players are using as support, and It’s not going to be right down at the tip of A’s low (although the market might overshoot to that level again)…
Support is now most likely to be at the high-volume area where the bulk of the buyers stepped in to create the reversal.
Their volume tells us that’s the price level they deemed to be important and the market tends to retest those levels.
So let’s have a look at the chart again after we’ve plotted some new support lines:
So we’ve moved the support line higher at point A. And we’ve also used the bell-shaped curve of reversal-forming volume at point B to plot a second level of support.
See how the market reacts to those levels as time moves on?
You had an opportunity to trade at points B and E using the support level projected from point A. And you had further opportunities to trade at points C & D using the support level projected from B.
All these opportunities were overlooked by simply focusing on extreme highs and lows.
Now remember, the Forex markets don’t give accurate statistics for volume traded. The cross-section of volume requires you to VISUALISE how the market is behaving at those pivotal reversal points. But the good news is there’s an easy way to do it.
How to Find Your Own High Volume S&R Levels
Find the significant highs and lows in the market. Zoom-in on the bars that formed the reversal points. And then…
1) Mentally ‘snip-off’ the candlestick wicks. They often represent the ‘long tail’ of volume distribution. We want to pay attention to the candlestick real bodies.
2) For a Type A reversal – where we have a long candle printing the extreme high or low: Take the real-body of the next shorter bar and project a support or resistance level from the midpoint. That will serve as a good proxy for the peak in volume that created the reversal. See point A on our example chart above.
3) For a Type B Reversal – where we have a single short candle printing the extreme high or low: Use the real body low of that candle to project a prospective resistance level (that’s where the candle marked an intermediary high point) and vice versa – use the real body high to project a new possible support level (where the candle marked a new low). See point B on the example chart above.
So there’s some food for thought for you… go away and have a play around with that idea. See if you can find yourself some new levels of support and resistance.
In next week’s eletter we’ll move on to look at ideas for taking trades off our new levels. We’ll check out ideas for reversal trades and also breakout trades when the levels are penetrated.
Be Prepared: Market Moving Data Coming This Week (London Time):
Wednesday 6th August 2014:
09:30 GBP Manufacturing Production
Thursday 7th August 2014:
12:00 GBP Interest Rate Decision
12:45 EUR Interest Rate Decision
13:30 EUR ECB Press Conference
Friday 8th August 2014:
– no big reports
Monday 11th August 2014:
– no big reports
Tuesday 12th August 2014:
10:00 EUR German ZEW Economic Sentiment
I hope you found my support and resistance method useful. Let me know if you find any good levels yourself and I’ll catch up with you again next week.