Why static horizontal areas are so important?
The reason lies in the ability we all have as traders to easily eyeball where these areas are located in the chart. This makes such horizontal areas the most universal form of reference for participants to use. It also makes the selection of these battlegrounds objective in nature as the market can easily agree on the location.
As a result, horizontal support and resistance areas act as a magnet to attract and repel prices due to the liquidity that resides near-by. Since every participant can spot the whereabouts, it is precisely at these junctures where the larger share of stop placements will be found, which creates pools of concentrated liquidity, hence areas of interest worth fighting for.
Accounting for these dense layers of orders stacking is absolutely essential for large players with a need to transact hundreds of millions of dollars either on behalf of their clients or for purely speculative purposes. Besides, areas of support and resistance become the bread and butter where market makers will look to intervene in anticipating of rotational movements.
Have you ever asked yourself, what would happen if large sums of capital were to be transacted around thin liquid areas? Plain and simple, big players would be shooting themselves on the foot by getting poor entries. Why is that? Because the lack of counter-parties to fill in their orders would lead to average entry prices that are far from ideal.
An option widely used is to split up large orders into fractional blocks (smaller lot sizes) to disguise the big core positions, what’s referred to as iceberg orders.
That’s why major players are especially active around these areas of high liquidity. The viral and often misunderstood term of stop loss hunting is simply a by-product of the normal market dynamics in need to seek out pockets of relevant liquidity concentration. Thinking that these players are there to get u is nonsense. Liquidity is the oxygen of every large player, it’s essential to have them involved at the size of trades they intend to. There is no better place for large players to get involved than at the areas this article will teach you to identify.
The Truth About Forex Brokers (Things You Must Know)
I trust you are enjoying the article so far. I just wanted to drop a quick line to let you know of a recent video interview that Jeremy Kinstlinger, Co-Founder at Global Prime, had with Etienne Crete from Desire to Trade. Jeremy exposed some of the truth about Forex brokers that you might not be aware of. A must watch.
Factors in the selection of support and resistance
I’ve listed below the different factors and concepts that will assist trades in identifying high-quality horizontal support and resistance areas. While drawing the right areas of horizontal support and resistance can be quite discretionary at times (not an exact science), the list below offers a guide to make the task more objective and quantifiable.
Let’s put a debate to bed: Areas vs levels
We tend to see the camp of traders endorsing the drawing support and resistance taking the candle closes as reference. Then we find the camp that tends to select the tails to draw support and resistance from. There is no right or wrong. What matters here is to understand the concept of liquidity to approach charts from the right perspective. The market often will distribute pools of liquidity at different intervals. Therefore, if you think horizontal support and resistance can be represented by the close of the candles, you are right. If you think about the tail and beyond as an area rich in liquidity, you are also right. Bottom line? It’s a holistic approach where you must account for both. This makes support or resistance based on areas the most optional visualisation technique as the premise here is than liquidity gets distributed and consumed within broad regions.
Top-down: Don’t lose sight of the forest for the trees
The higher the time frame, the more relevant the area of support and resistance identified becomes. You must think about the top-down order of timeframes as dissecting the anatomy of a chart by studying the structure of its parts. As we move up in time frames, each candle contains greater amount of information. What this translates into is that the higher we go in identifying support and resistance area, it will invariably represent an opportunity by major players to find larger and larger pockets of liquidity to fill in their orders at the best average prices. Now, this final piece of advice is key. To limit the risk of suffering analysis paralysis, which is nothing else than an overdose of information, you should be pragmatic by looking to select these areas in a handful of time scales. A good rule of thumb tends to be a multiplier of 3 to 6. For instance, you can select your go to timeframes as the daily, the 8 or 4 hours and from there go down into the 30m or 1h.
Zoom out not to miss key data point
You must go through the process of selection support and resistance areas by squeezing the charts so that you can visually identify the maximum number of interactions a particular area has exhibited in the past. It takes screen time and training your eye just like any intellectually challenging and technical endeavour. That said, anyway you slice it, it all starts from the very foundation of the ability to get enough data points of reference. It’s often said that history doesn’t repeat but will often rhyme. This too applies to areas of support and resistance. By zooming out the chart, it therefore help us to develop a much-needed eagle-view of a chart’s history.
Recency: Markets adapt based on new information
The more recent the formation in the make up of a new horizontal area of support or resistance, the more relevance to potentially assign. The markets are constantly evolving by adapting to new incoming information, that’s why the further back a support or resistance goes, the less relevance potentially holds. An area in the hourly chart that was formed 10 days ago may not hold as much relevance as one that just occurred in the last 24 or 48h. At the end of the day, it’s important to take a holistic approach by accounting for both the recent activity as the heavyweight barometer, but at the same time, understanding how many times in the past this area has also acted as a turning point, what’s achieved, is liquidity still likely to reside there?
Velocity: Intensity of the supply/demand imbalance
How impulsive the price departs a specific region will determine to a certain degree the quality of that area on a retest. The more impulsivity or velocity away from the onset of a support or resistance formed, the more pronounced the imbalance of supply or demand. That’s a universal principle of supply and demand that all market participants will immediately agree on. This leaves a distinctive residual supply/demand imbalance trail. The stronger the departure, the higher the interest may be to re-engage in these areas on a retest. The factor of impulsivity is one of the main aspects that adds credence to calling a quality support and resistance.
Freshness: A measure of the residual demand/supply
The first test of the backside of an SR tends to be the most powerful as it’s that first test that still occurs within the context of a developing trend and supportive market structure most likely. There is a psychological component as well whereby those that were looking to buy/sell at that SR recognise they were wrong, so the aim is to mitigate position which ignites the reversal on a 1st retest. The more times the level is tested, the more dubious the market structure becomes and the more we potentially exhaust the liquidity at that level.
Accomplishments of the price movements
How the price departs from a specific price point. However, the impulsive departure is just one aspect that adds credence to the area of support and resistance. The second important component is how much ground did the creation of this static horizontal area of support or resistance gain? Don’t get caught up in one qualifier alone, the holistic nature of technical analysis is key.
What invalidates a support or resistance area
As important as it is to select an area of support or resistance where we anticipate a potential change in direction, it’s also cardinal that we come up with some rules to invalidate it. To determine that, the concept of acceptance and rejection above or below these areas is the most effective calibrator. This is the rule that I personally apply to dim a support or resistance as compromised. In fact, despite recognising that support and resistance should be treated as areas vs lines, if I can pinpoint a specific level where price failed to close beyond in several occasions followed by an ultimate close violating that well defined level (on a closing basis), that tends to be sufficient evidence to speculate on that SR compromised and start to be tradable on a retest.
Trade horizontal areas in line with market structure
The best trades you will ever find off horizontal areas should occur in line with the dominant market structure. Therefore, you must constantly ask yourself if the retest of a good quality area of support or resistance happens to be under the right context. We should interpret the term context as whether or not the market structure is favourable for a potential rejection of the area or does the current contextual setting heightens the risk of a support or resistance failing to hold.
These were the main qualifiers to filer out the wheat from the chaff when it comes to the selection of quality support and resistance areas. The next logical step is to go through any chart and start practising the identification of these high areas of interest. I will reiterate that the more you practice this routine, the better you’ll the areas from which to calibrate your risk reward.