Recent price data can show you the future…
Okay, it’s a bold claim.
But I can show you how to use recent price data to find some pretty good clues about where prices may be heading.
There are a lot of good things about being in a long-term trending market. However, in these conditions we’re often coursing uncharted territory – prices we haven’t visited before, or at least not for a long time. That means that we don’t have much information about how prices react at these levels.
The heady days of long-term bull markers appear to be behind us (for now). And the new trends and choppy territory we are experiencing on many of our charts will leave many traders feeling uneasy.
However, these charts offer us an advantage that we need to capitalize on. That advantage is recent price data – we’ve seen most of these price levels recently, so we have information about what traders do at these levels. And, if we’re smart, we can plunder this information for clues about what will happen in the future…
Here’s an example from the end of last week, which shows the GBP/USD price bouncing off the level of 1.53…
As you can see, it’s no coincidence that Cable bounced back off this level, and it won’t have come as a surprise to any investor who’s already got this line drawn on their charts – it’s done exactly the same thing the last two times that it met this price (back in December and September last year).
These kinds of clues are all over our charts – and a few minutes spent drawing some lines will be well spent when it comes to intelligent placement of your profit targets and stop orders…
How to draw support & resistance levels
Support and resistance are probably the most widely used and important concepts in trading.
In a practical sense, a support level is a price at which buyers come into the market, in the belief that they’re getting in cheap – and thereby increasing demand and pushing up the price.
Resistance is a price level at which traders sell – believing that the price is high. This selling price pushes the price down.
In technical trading books, you can find lists of rules about drawing in lines of support and resistance.
1. The market needs to get rejected at least twice for it to count as support/resistance.
2. The more often your level is tested, the more valid it becomes.
3. The more recently a level has been tested, the stronger its support or resistance.
4. If support is broken, that level becomes resistance. Likewise, if resistance is broken, that level becomes support.
These rules are all well and good, but… I often find myself ignoring them!
What’s important about your support and resistance lines is that they are useful to you. So when you draw them – think about how you will use them.
A support or resistance line is there to tell us that the price has hit this level, and then reversed or consolidated at it. It might be a “one-touch” market top or bottom. Or it might be a level that the price has repeatedly pushed against with many, many touches.
Ideally, we’d have two contact points – the more contact points you have (i.e. the more times the price has bounced off that level) the stronger the support or resistance becomes. But this doesn’t mean that single touches should be sidelined.
You can also give yourself some discretion about just how “wide” your lines are – support and resistance are rarely found at exact numbers, and viewing them as “areas” or support and resistance, rather than “levels” can be helpful.
Using these lines to build up clues
So, how do you apply these in your everyday trading?
If you’re usually day trading, it can be easy to miss these big, important levels, as they simply won’t appear on your 5 minute, 10 minute, or even 1 hour charts.
My advice would be to take a step back.
Switch over to a daily chart… and take a look at the left of your screen. Look for areas which might offer support and resistance, or even some consolidation – and draw some lines.
Now, when you switch back to your shorter timescale, you’ll have these levels logged. So, if you’re about to place a stop level or profit target near one of them – you’ve got a reminder there of where these key levels are, and you can ensure that your stops and targets are on the right side of them.
By taking this step back to get a bigger picture, you can avoid making obvious mistakes in the heat of the moment when you’re intraday trading.