Trading Supply and Demand
Have you ever been stopped out of a trade? While losses are part of trading, the proper application of support and resistance lines can decrease the amount of times you are stopped out. If you are familiar with my trading videos, you might have noticed that simple support and resistance is my favorite method of entry. In my opinion, support and resistance lines, when drawn in a certain way, offer a trader the most objective form of technical analysis. While support and resistance lines are reliable, the price specific reference point you obtain when using them is what aides a trader the most in regards to their trading decisions.
How do I draw support and resistance lines?
The common question asked in regards to drawing support and resistance lines is whether or not to include the wicks when connecting price points. In my opinion, not allowing prices to penetrate your support and resistance line, at least for the first two price points of the line is the key to drawing an objective support and resistance line. I am not saying that using the body is wrong. It is not really a matter of right or wrong. The key point is that if you do not allow prices to penetrate the line, then there is no debate as to where the line actually is on the chart. A common mistake I see is that traders immediately re draw the line after a penetration, or simply allow the penetration and keep the same line. In my opinion, this degrades the value of the support and resistance line as a technical indicator, especially in terms of remaining completely objective as a trader. For example, if a trader is in a position based on a clear support line and it moves against them, they might look for ways to rationalize staying in the trade to avoid taking the loss. One of those ways would be to slightly alter the rules of applying support and resistance line. This is a very subtle shift in thinking, but can have disastrous effects on your account equity.
How do I enter using support and resistance lines?
The key in using support and resistance lines is to wait for prices to actually approach the support or resistance line before entry. Here is an example:
On the chart above, I have added two resistance lines. Line 1 allows price to penetrate on several occasions. We can notice that price has now approached point A on line 1. A trader might feel as though they are entering at a clear resistance line near point A. I would argue they are not. I would argue that this reveals a lack of patience. Contrast this to Line 2. This line does not allow prices to penetrate. A proper entry would be at point B on Line 2. Drawing support and resistance lines in this manner forces us to be more patient when entering trades and re-enforces proper risk management.
Here is a good example of an entry utilizing a resistance line that is correctly drawn in the current market environment. The USD/CHF, which is in a strong downtrend, is approaching a resistance line.
Price is currently at .8919, the resistance line is located at .8935. We might utilize entry orders and place an order to sell short at .8930 with a stop at .8955. Since we are risking 25 pips on the trade, we might look for a 1:2 risk to reward ratio and place a limit at .8880.