What to do Once You’ve Found Support and Resistance
Part 2: Continuation Trades
It’s the last part of our support and resistance series today… trading continuations!
Two weeks ago we looked at ways to find support and resistance (S&R) and how to plot them on your charts. And then last week we worked through some techniques you can use to take reversal trades from S&R levels.
(Drop me a line – kato – if you’re missing either of the last two eletters. I’ll email you a copy by return so you have the complete set.)
So this week we’ll complete the picture by looking at the best ways to take continuation trades. These trades are the other side of the coin to reversals. Instead of being repelled by S&R like reversals, continuation trades happen when the market crashes through levels of support and resistance, and then keeps on moving!
Continuations occur when an anticipated S&R level fails. It just means either the buyers were more aggressive than the sellers (or vice-versa) at this pivotal point in the market.
So in the diagram above, the continuation (the green line) happened when the market approached the S&R level and the sellers failed to overpower the buyers. The buyers absorbed all the sell orders and demand for the underlying asset continued… the price carries on being driven upwards!
On the other hand, the reversal happened as a result of the sellers holding the stronger hand. They were lying in wait, looking for a good entry point into a trade, as the market approached the S&R level. They sprung their trap, swamped the buying interest and drove the price lower. The price will now continue to move lower until it meets a new band of buyers ready to step forward and throw their money into the ring.
What Support and Resistance Is Really Telling You
KEY POINT: Support and resistance (and all technical analysis really) is simply a case of analysing the power of two opposing forces – the buyers and the sellers – as they lock horns. The current market price (and the direction the price is moving in) reflects which party is currently most aggressive.
Retests (or Resistance becoming Support)
The way I’ve drawn that first diagram of the continuation trade is a bit of a simplified example. It’s not too often you’ll see the market cut so cleanly through S&R and continue on its merry way.
What you’ll often see is something more like this:
A price level that previously provided (or potentially offered) resistance will frequently become support once price establishes itself above the level. It works exactly the same the other way round too – support can become resistance.
Remember how the market has a memory and likes to revisit key price levels? Well this is another example of that principle at work.
And it can offer you two advantages when it comes to finding good continuation.
Two Reasons You Can Get Better Results by Waiting for the Retest
- If you wait for the retest you can reduce risk by avoiding taking trades on that initial break though the S&R level. I’ll walk you through an example of this in a minute but the first penetration of the level is going to attract the most action. It can be a real battle ground as the buyers and sellers trade blows. The price can really fly around on increased volatility and you can often get stopped-out of what would have been good trades… if you’d only waited a little bit longer
- By waiting to see a retest you can also increase profit potential. You’re jumping into a higher probability trade because the market has already shown you whether the buyers or sellers are in control. And you can get yourself nicely positioned just before a fresh spike in momentum comes in and carries your trade rapidly upwards.
So let’s have a look at how you can use your knowledge of support and resistance to find higher-probability trades. Here’s a good example on the daily chart of GBPUSD:
Let’s say you’ve got your eye on that high labelled ‘A’. You know resistance can be expected at the dashed line (remember how we look for the high-volume area that the market pivoted around as it printed the highs). But at the moment you don’t know whether the market will reverse or continue.
The Safer Way to Trade Breakouts
The common way to accommodate a continuation trade is to buy as the market breaks out beyond the tip of point A. You might have a Buy Stop order working as the market moves higher. It gets you into a trade if the market does not reverse at the resistance level.
But here’s the problem with that approach… as you see on the example above, the market will often take out spike highs and lows just to liquidate the obvious stop orders that have accumulated there. You’ll often see the market poke beyond the high point and then stall – there’s no real momentum behind the continuation at this stage.
If you were a buyer you’ve now got decisions to make. Do you hold on to the trade if you’ve not already been stopped out? Do you bail out now to avoid the risk of the market reversing?
Buying breakouts can work. But I think there’s a safer way to do it.
If you wait until the market has moved beyond the tip of the highs the stop orders will have been liquidated. So that’s the market’s first priority out of the way. You can then observe the price action and get a good idea whether the market has the legs to carry on moving up.
You can use the concept of resistance becoming support to place higher-probability trades with less risk and greater profit potential. Here’s how you might have done it:
Wait until you see the market firmly established above resistance and beyond the breakout point (A). A Buy Limit order can then be left working just above the old resistance level – you’re now looking for it to become support. Put a stop loss in to protect yourself against any calamities and wait to see what happens.
A few days later we get the dip down to retest the Resistance/Support level filling you on your buy order. You already knew the market had potential to make new headway to the upside because resistance had already been taken out. The retest now holds firm and it’s at this point the real buying comes into the market.
Your trade is quickly propelled to a 3:1 reward to risk situation by the new buying momentum coming in shortly after your entry. Smiles all round!
Of course, you won’t see a perfect reversal on the daily chart every time the market breaks out. But remember, good trading is all about playing the probabilities. Why not wait until the market has shown you what is likely to happen next rather than leaping in blind?
Be Prepared: Market Moving Data Coming This Week (London Time):
Wednesday 20th August:
09:30 GBP MPC Meeting Minutes
19:00 USD FOMC Meeting Minutes
Thursday 21st August:
08:30 EUR German Manufacturing PMI
09:30 GBP Retail Sales
15:00 USD Existing Home Sales
15:00 USD Philly Fed
Friday 22nd August:
15:00 USD Yellen Speaks
19:30 EUR Draghi Speaks
Monday 25th August:
All Day UK Bank Holiday
09:00 EUR German IFO Business Climate
15:00 USD New Home Sales
Tuesday 26th August:
13:30 USD Durable Goods
15:00 USD CB Consumer Confidence
So there you go… I hope you found our look at support and resistance over these last three weeks useful. By now you know how to find reliable and accurate support and resistance levels. And you know how to take good trades from them either way – reversal or continuation.
Let me know how you get on trading them!
