Remember last week we discussed ways to find good support and resistance levels by reviewing recent price action?
Well this week we’re going to start looking at ideas for taking trades off your levels once you’ve got them in place.
So first of all, I’ll quickly review the concept we’re using here…
The support and resistance levels we’re using are basically price zones the market has indicated to be significant. They are ‘balancing points’ between buyers and sellers – the tight bands of pricing at which previous dips and rallies fizzled out.
And the market keeps these prices tight in its memory bank…
If price action creeps back to them all eyes are peeled to see how they will be treated on this next occasion. Depending on what happens on the retest – whether price reverses or breaks through – they can indicate if buyers or sellers have the upper hand. And this can help keep you trading in line with the underlying bias at work in the market.
We also need to keep in mind the concept of support becoming resistance (and vice-versa). This is where a price level that provided significant resistance can actually become a reliable level of support once the market breaks through and establishes above it. Again, it’s down to the historical activity that took place in this area.
So there are two trading methods to keep in mind when looking at support and resistance (S&R).
Two ways to Trade Support and Resistance
1) Trading the Reversal: This is where the market approaches an S&R level and you prepare yourself to take a trade against the immediate short-term trend. For example, the market might be moving upwards but you’re getting ready to sell (place a short trade) as the price hits a previous level of resistance, stalls and reverses.
2) Trading a Continuation: This is where the market approaches an S&R level and crashes straight through it. The move can actually gain momentum as market players jump on board with the market breaking out into new territory. If you keep yourself aware of the key levels you can get an early toehold on the new trend as it breaks through. You can trade the continuation of price as it moves through and beyond the S&R level.
I thought we’d look at some ways to trade the reversals this week and then move on to the breakout trades in next week’s eletter.
How to Take Reversal Trades Off Support and Resistance Levels
So here we are on the daily chart of GBPUSD. It’s pretty recent activity – June 2014.
I’ve labelled up some areas of interest…
The dashed line extends from the real-body of that spike-low candle from mid May. That bar marked a significant low before the market rallied higher throughout May and into early June. We’re looking at that as a pivotal level in the market now. It’s a price zone which marked the baseline of recent Bullish dominance and one which should see some buying activity come in again if the market goes on to retest it. We’re looking for that level to offer support.
The circled area marks the point at which the market dropped down and tested our support. You can see the buying interest come in and a real tussle going on between the bulls and the bears right on top of the dashed line. It looks like the Bulls have secured a short-term victory – the market has popped up off support in recent days. And we now have a new secondary level of support to potentially trade off. Here it is:
We’re taking a new support level off the real-body of the candle that marked the most recent low. We’ve also got that longer-term level of support sat right below so it should give us a good opportunity to look for a reversal trade. If the market drops back down to our new level of support we’ll look to BUY in anticipation of the market bouncing back higher.
And here’s what happens next:
You can see the market reverse straight off our new level of support before rocketing higher. So how could you have traded this opportunity yourself?
I think there are three common ways to look at this. You can obviously be as creative as you like but these three ideas should give you a good starting point.
Three ways to trade the reversal
1) Have a resting Buy order in the market that gets you into the trade on a retest of support. Here’s how you might have set up your orders for this trade:
The Buy Limit order sits working away all on its own until the market hits your specified price and automatically gets you into the position. You might have had your limit order placed just above the level of support with a protective stop loss order below the very low of the candlestick.
It’s a more risky approach – you’re entering the market before any sign of buying in the market – but it’s a great way to play support and resistance levels if you can’t watch the market in real time.
And on this occasion you would have been rewarded with a 5:1 reward to risk trade within 8 days – not too shabby from the daily chart!
2) Wait for buying to come in and buy a move higher. With this method you wait for signs of buying – confirmation that support or resistance is being observed by the market – before you commit yourself. It’s a more conservative entry but you’ll usually give up some pricing advantage by getting in a way above support or below resistance. Here’s how you might have done it in this instance.
You’ve seen signs of buying come in to the market at the support level on the blue up-candle. You might now try to get into the trade by buying a breakout above the high of the blue bar with a Buy-Stop entry order and your protective stop loss placed just below the low of the bar (and just below the support level for extra insurance!). You didn’t get in at quite as good a price this time – it was around a 4:1 reward to risk trade – but you did have some peace of mind that the market had already shown signs of the reversal before you jumped in.
3) Use intraday price action to fine-tune your entry. This method can give you incredible reward:risk trades if you are able to watch the markets in real time. Here’s how you could have used the 60 minute chart to your advantage:
Here we see two strong bullish candlestick patterns within a couple of hours of each other right on the level of support. First we see a bullish Doji pattern followed a few hours later by a Bullish Engulfing pattern. Taking an entry on a break above either of those bars would have given you 30 pips of risk if you kept your protective stop below the 60 minute bar lows. Once your entry had been secured you could then use the daily chart to manage your exit. Taking the same exit point as the two examples above would have given you a 10:1 reward to risk trade.
And those are the opportunities that can really boost your account balance!
Be Prepared: Market Moving Data Coming This Week (London Time):
Wednesday 13th August 2014:
09:30 GBP Claimant Count Change
10:30 GBP BoE Carney Speaks
10:30 GBP Inflation Report
Thursday 14th August 2014:
07:00 EUR German GDP
10:00 EUR CPI
Friday 15th August 2014:
09:30 GBP GDP
13:30 USD PPI
Monday 18th August 2014: – no big reports
Tuesday 19th August 2014:
09:30 GBP CPI
13:30 USD Building Permits
13:30 USD Core CPI
I hope you enjoyed our look at trading reversals off S&R. Keep an eye out for those opportunities and we’ll cover the breakout trades next week.
