The Traps of Support and Resistance
Read any textbook or article on the fundamental aspect of Technical Analysis and no doubt, they will feature the concepts of Price Support and Price Resistance. In my own trading educational journey, which began almost 20 years ago, these were the basics I learned initially, and they were most definitely useful to some extent. In fact, it should be made clear that the purpose of this article is not to scorn the concepts of support and resistance. They are powerful analytical tools, but only when used with a rules-based trade plan. However, like any technical analysis technique, they have their flaws too. Nothing works 100% of the time but we can increase our odds of trading success when we stack probability on our side and learn to avoid the common traps most novices fall into.
The best way to illustrate this concept is with a recent trading example from one of the Pinnacle Institute’s Live Trading rooms. In this twice-a-week session called the Open Exchange, we focus on both Day Trading and Swing Trading opportunities in major futures markets and individual stocks. From our session on October 4th, we highlighted a possible short trade setup on Silver Futures (SI). The chart looked like this:
Notice the qualified Supply Zone? This area showed us objectively that there was likely a major supply/demand imbalance, giving us a short entry at 21.16 with stops above 21.53 and targets below around 18.60. This trading opportunity represented a typical setup using the Pinnacle Method of market timing, rather than embracing the common method of sell at resistance and buy at support.
If we look a few days later, we can see the outcome of the trade:
By highlighting the supply zone as such, we obtain what we call a distal line for our stop loss guidance and a proximal line for entry guidance. This method also allows us adequate room for capturing the trade and ample room for the stop loss order to be placed in a defensive position. The unique nature of a zone entry also shows us the optimal entry area for our setups, offering a more refined approach than support and resistance.
As we can see from the chart below, using a classic and conventional “sell at resistance” strategy would have worked out very differently:
We can see that not only would we have entered the trade short far too early by selling at the resistance line of 20.60, but we would have also been likely stopped out and endured a trading loss, only to see prices then reverse and drop lower as expected.
As trading systems and the markets become more sophisticated, we as speculators must learn to cut through the noise and focus on what’s real. The markets will always tend to show you the way, that is if you know what you are looking for. By embracing the true dynamics of price action (Supply and Demand) above more conventional methods of trading, we have a greater opportunity to work towards a lower risk and potentially higher probability way of trading.