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Demand and Supply zones
What is Supply and Demand trading?
Goods are bought and sold at what their perceived value is at the time. The same applies for financial instruments, with the expectation that their price will change in the future and will be bought or sold at differing prices, potentially bringing a profit for traders.
Prices adjust according to willing buyers and sellers, in-turn creating supply and demand zones, the sellers represent the amount that is available for sale (supply) while buyers represent the amount
available to be bought (demand). It is when there is an imbalance between buyers and sellers that we see a change in price, for example, when there are more willing sellers, price will begin to fall until it finds more buyers and when there are more willing buyers, price will rise until it finds more sellers. Knowing where these areas are on a price chart will give you an edge, and allow you to follow the interests of big/smart money, the real market movers.
Identifying Supply/Demand zones
First we look at the chart for an area where price strongly shot up from (demand) or dropped away from (supply).
The next step is to mark the base of these moves.
We always mark the outermost limit of a move, marking the inner is a personal preference for each of us depending how loose or tight one wants to keep their zones.
RBD DBR and RBR DBD
As price moves it creates (swing) highs and lows, the extremes of these moves can be marked as “bases”, just like the ones marked above. When bases are created after a “rally” or a “drop” they form a Rally-Base-Drop (RBD) or a Drop-Base-Rally (DBR).
Price can also create small bases along a rally or a drop, these smaller moves are known as Drop-Base-Drops (DBD) and Rally-Base-Rallies (RBR).
Balance vs. Imbalance
During the formation of a base, we consider price to be in balance. This is because there is not a significant difference in the amount of buy or sell orders in this area thus price doesn’t rally or drop as long as this balance exists. For price to start moving in a direction there needs to be more of one type of order (buys or sells) than the other causing price to rally or to drop, it is at this point a base is confirmed and a decision that price was either too cheap or too expensive has been made. When price moves away from a base there are naturally unfilled orders which remain, so when price returns to the base in the future we can expect the remaining orders to be triggered causing a reaction in price. It is this what supply/demand traders try and take advantage of.
When Supply/Demand breaks
After a level is tested many times or during a strong move, Supply and Demand levels eventually break. This can be due to the once remaining orders being triggered and gradually removed, or an
overwhelming amount of orders in the opposite direction breaking the level. Orders can even be removed manually by a trader who formed the level.
Every broken supply/demand level holds some significance. Where once were more sell orders (supply) now more buy orders remain/exist, with the opposite applying for demand levels. This means upon return to a broken level, we could see a reaction in price, these levels are often referred to as “swap” levels. It is at these levels where we can look for conformation to take a trade. This is how the look on a chart:
Part 2: Supply and Demand as reactions to the FTR
Wouldn’t it be nice if we were able to trade supply/demand levels knowing when one will hold or when one will break? Well believe it or not we can, because as hard as it may sound supply/demand levels are NOT created equally! There are some that are much more important than others, and some even further beyond important. Most articles on supply/demand will mostly have you read about “reactions” to levels, because that is what is important right? Sure, they are important if all you want to do is look at the far right of your charts and gamble, but what are the supply/demand levelsthemselves reactions to?
Hopefully we have pricked your attention, because this is going to be the first time something as important as this will be covered in a supply/demand article and it is very exciting to be writing about. I can already hear you all screaming; hold on! Supply/demand levels can be reactions to other
supply/demand levels! Or Support/Resistance levels! Or MA’s and fibs! Please…If you are still using MA’s and fibs, let me direct you to our technical analysis article.
The truth is; supply/demand are often reactions to the Flag Limit (a RBD or DBR after a break of a high or low). You can read about the FL here. It is these levels that are the important ones, the ones that will contain price in a range, and give you the heads up when price is going to change direction. Sure there are other areas and reasons supply/demand forms, just like the ones you yelled at me earlier, but these are lesser important levels, ones that are much more subjected to breaks and fake moves! Knowing the important ones will keep you on the right side of the market at all times.
Here is some help on defining these levels, but remember, to truly understand them you need to find and mark them out for yourselves!
There are plenty of other supply/demand levels which I did not mark, but they would all hold lesser importance than the ones formed after the breaks of highs or low. However, important levels can also break so it is important to monitor these levels for signs of reversals. When they break however, they hold a lot of importance.
You can see from the image above I marked a DBR after a break of the highs to the left of it. This is a level that forms after a break of a high, it’s a FTR, and we can expect it to bounce price, but it doesn’t, it breaks. The FTR that proceeds is the RBD that is the important one, this is where we want to keenly look for PA.
How to trade Supply and Demand Areas
Conventional supply and demand trading teaches the game of probabilities; by trading enough zones, with a decent enough RR, one should make money. These levels are in general blindly traded with a stop just above, and a target at the next level, this is very often done with limit orders, longing there is a decent enough RR (2:1 is usually good enough).
If a proper plan is in place, this method will make you money, but it is still essentially gambling, and here at RTM we don’t gamble. We want to be absolutely sure a level is going to hold, and once we know, we want the very best RR on every trade we take (yes 15:1 can be more common than you think!). By looking for PA in the correct spots, there is no reason you shouldn’t be able to get into great trades, with great rewards and very little risk. You can find everything you need to know about PAin
the markepediasection. So get to work, log your progress in the homework section and join our great community.
Support and Ressitance
What is Support and Resistance?As price moves it creates highs and lows, these often provide “support” or “resistance” when price returns. This happens because more orders of one kind are in that area (buy or sells). When no more orders remain in these places, price will go through and we say that the support/resistance level “breaks”. This is essential for price to move, otherwise it would be trapped inside a range forever. So support and resistance is important as is its breaks.
But first let’s see what it looks like.
It is a common misconception that the more times price bounces off Support or Resistance then the stronger that level is. Every time price bounces off them a decision is made on price value (if price is cheap or expensive). But as we said price bounces off these places because one type of orders (buys or sells) are more than the other. Each time price visits, it consumes orders. At some point price will go through as there will be no more opposing orders there any more and this is what makes a Support or Resistance level to break.
It is very common for price to break Support and Resistance levels, old highs and lows break as the orders get depleted from them and price moves through. Broken S/R areas will often react on return as now more orders of the opposite kind remain unfilled in these places.
How to find S/R levels?
A common practice is to zoom out like in the chart below so you have a wider picture of the area you look at. Then look for places that price bounced off and mark it with a horizontal line. See how price often respects these lines, then breaks them and when price returns they often get respected again. Support becomes resistance and the opposite.
Of course you will see many times price breaking through and then reversing, often this is called a false break (false breakout, or fakeout are some other names commonly used). The simple reason this
happens is because price looks for liquidity and this often happens in these places as traders trade these breakouts from S/R and get trapped, having their stops hit as price “fakes” and moves in the other direction.
Further Study
https://www.tradingview.com/chart/EURUSD/DZblrqHg-How-to-draw-Supply-and-Demand-zone-EDUCATIONAL/
https://www.tradingview.com/chart/EURUSD/0CHocSUo-HEAD-AND-SHOULDERS-PATTERN-SECRETS/
Price Action Theory
http://www.tradingsetupsreview.com/how-to-identify-demand-and-supply-using-price-action/
YOU ARE HERE: HOME / TRADING ARTICLES / HOW TO IDENTIFY DEMAND AND SUPPLY USING PRICE ACTION
HOW TO IDENTIFY DEMAND AND
SUPPLY USING PRICE ACTION
Want to find demand and supply in the market? Just look at the market depth screen and you will see orders to buy and sell at different prices. Those numbers show demand and supply.
That’s all. You’ve found demand and supply. What can you do with it? Nothing. Now, think again. Do you really want to find demand and supply?
In a liquid market, there is constant supply and demand. People are always willing to buy and sell at different prices. Demand and supply are everywhere. There is no need to find them.
What you really want to find are the price zones where supply overwhelms demand and where demand overwhelms supply.
The former is known as resistance. When the market bumps into resistance, price will drop. Then, you can make money by shorting the market.
The latter is market support. With the support of demand, price will rise. Then, you can profit from a long position.
In a nutshell, we want to find market turning points, and not merely demand and supply. Follow the three steps below to find and trade these profitable turning points.
1. FOCUS ON A PRICE LEVEL (ZONE)
It’s difficult to analyze the market without a focal point. If you look for turning points at every price level, you will only find confusion.
How do you know which price level to focus on? Which price levels are potential market turning points?
There are many ways to find potential turning points. You can use swing pivots, calculated pivot points, Fibonacci levels, and volume signals. Learn about these methods and make use of those that make sense to you.
EXAMPLE
In this example, I focus on a valid swing pivot. (The concept of a valid swing pivot is explained in myprice action course. Essentially, it is a form of major market pivot.)
The ES 5-minute chart above shows a valid swing low. Pay attention to this price zone to find out if demand prevails.
2. OBSERVE WHAT HAPPENED (HAPPENS)
AT THE POTENTIAL SUPPORT/RESISTANCE
SIGNS OF STRONG DEMAND
When the market tests a potential support, look out for:
Bullish price pattern
Inability to clear below the support Increased volume
Congestion
SIGNS OF STRONG SUPPLY
When the market tests a potential resistance, look out for:
Bearish price pattern
Inability to clear above the resistance Increased volume
Congestion
Look for these price action signals in the past, as well as in real-time price action. The more signs you see, the more likely you’ve found a true support/resistance zone.
EXAMPLE
Let’s take a closer look at the same ES 5-minute chart to check the price action.
1. Volume increased as the market dipped into the price zone. It was a clue of a demand surge. 2. Bullish price patterns formed as the market tested the support zone. (Marubozu and Outside Bar) 3. It was clear that the market had difficulty closing within or below the support zone.
These signs confirmed that demand would likely overwhelm supply in the indicated price zone.
3. LIMIT YOUR RISK
Once you’ve found a potential support or resistance level, remember the word “potential”. It is a tendency and not a guarantee.
Hence, you should limit your risk when you trade supply and demand zones. There are two trading approaches to do so.
METHOD ONE – DEMAND CONFIRMATION
Let price show you the way. Look for price patterns. Then, use stop orders to enter as the market confirms your opinion.
You will enter late, but you will save yourself from many bad trades. The main drawback of this strategy is that you will enter at a worse price. Hence, use this strategy only when you expect significant profit potential. Otherwise, the reward-to-risk ratio is too low.
METHOD TWO – TRADE AGGRESSIVELY
Get in early (without confirmation) with a tight stop-loss and a conservative target. In this case, use a limit order placed within the support/resistance zone.
This strategy is ideal when you are:
Confident of the demand and supply conditions; But are uncertain of how far the market would go.
EXAMPLE
In our ES 5-minute example, the support zone looked reliable. Hence, we were confident that demand would stop the market decline.
However, given that the market has been falling, long positions were against the recent trend. It was unwise to set ambitious profit targets.
A consistent stop-loss and target of 2 points will work for both trades. It produced two swift and high probability scalps. (The stop-loss and target depends on the market volatility.)
USE PRICE ACTION TO UNDERSTAND HOW
DEMAND AND SUPPLY INTERACTS
Remember that you are anticipating the strength of demand and supply. We are interested in their interaction.
Will demand conquer supply at this price level? Will supply overwhelm demand at this price level?
What does this (series of) price bar(s) tell me about demand and supply?
These are the questions you want to think about as you go through the three steps above.
As our example showed, the market context is crucial. It helps you to tailor your trading approach to the market.
Hence, don’t focus on a simplistic definition of support and resistance. Spend your effort in studying price action clues to decipher demand and supply forces.
INSTANTLY IMPROVE YOUR
TRADING STRATEGY WITH
SUPPORT AND RESISTANCE
By Galen Woods in Trading Articles on January 2, 2014
What is the best way to improve your trading strategy? Use support and resistance concepts in your trading strategy.
Learn how to use support and resistance levels in your trading strategy to improve your trading results.
WHAT ARE SUPPORT AND RESISTANCE
LEVELS?
Before you learn about support and resistance, you must first understand basic demand and supply.
Demand and supply are the underlying forces of price movements. Market turns up when demand overwhelms supply and turns down when supply overcomes demand.
(Technical analysis studies recurring price patterns that result from demand and supply changes. Fundamental analysis drills into the determinants of demand and supply.)
Prices move up when demand is stronger than supply. Buyers are more eager to buy than sellers are willing to sell. So buyers will offer a higher price to entice sellers. Price rises.
Prices drop when supply is stronger than demand. Sellers are more eager to sell than buyers are willing to buy. In this case, sellers will lower their asking price until buyers are willing to buy. Prices fall.
At support levels, we expect demand to overwhelm supply. When demand is stronger than supply, price will rise. Or at least, price will stop falling at the support level.
At resistance levels, as supply overcomes demand, we expect the price to stop rising and fall.
Take note that support and resistance are not clear-cut price levels. They occur over a range of prices. However, for convenience and clarity, many technical analysts draw lines to mark out support and resistance.
Drawing lines to represent support and resistance is acceptable as long as you understand that the lines actually represent zones where the demand and supply imbalance switches.
HOW TO FIND SUPPORT AND RESISTANCE
LEVELS?
SWING HIGHS AND SWING LOWS
Swing highs and swing lows are earlier market turning points. Hence, they are natural choices for projecting support and resistance levels.
Every swing point is a potential support or resistance level. However, for effective trading, focus on major swing highs and lows.
CONGESTION AREAS
Market participants have spent a prolonged time in congestion areas. It is likely that they have formed psychological attachment or have established actual trading interest within that price range. Hence, earlier market congestion areas are reliable support and resistance levels.
Congestion areas reinforces the idea that support and resistance are zones, and not a specific price level.
If you need help finding congestion areas, price by volume charts might help.
PSYCHOLOGICAL NUMBERS
Humans attach significance to certain numbers.
Round numbers are the best examples. Round numbers always make financial
headlines. TheNatural Number Trading Strategy derives its trading edge from round numbers.
The 52-week high and low price of a security is another example of a psychologically important number.
CALCULATED SUPPORT/RESISTANCE
You can also derive support and resistance from calculated values like the moving average. They work best in trending markets.
Combining candlestick patterns with a moving average is a reliable trading method that uses moving average as support/resistance.
Fibonacci retracement is another popular method for projecting support and resistance by calculation. With a decent charting package, we can mark out retracement levels easily without manual calculation.
Identify major market swings and focus on retracement of the move by a Fibonacci ratio.
Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8% and 100%. A 100% retracement is the same as using a swing high/low as resistance/support.
The intraday trend trading strategy we reviewed uses Fibonacci retracements to find the best trades.
FLIPPING OF SUPPORT/RESISTANCE
Flipping is an important concept for support and resistance. It refers to the phenomenon of support turning into resistance or resistance turning into support.
When price breaks through a support level, it shows a shift of power from buyers to sellers. The support level then becomes a resistance level that sellers are confident of defending. The reverse is true for price breaking through resistance.
This concept is applicable regardless of the method you use to find support and resistance levels.
SUPPORT/RESISTANCE FROM HIGHER TIME-FRAME
To focus on major support and resistance levels, you can find them on higher time-frames before applying them to your trading time-frame for analysis.
For instance, you can note down the support and resistance levels from the weekly chart. Then, plot them on the daily chart to find trading opportunities.
This method keeps you focused on important support and resistance levels instead of flooding your chart with dozens of potential support and resistance levels.
HOW TO USE SUPPORT AND RESISTANCE
LEVELS IN YOUR TRADING STRATEGY?
TRADING DIRECTION
In up trends, support levels are likely to hold. In down trends, resistance levels tend to hold.
Hence, if you see that support levels are holding up, you might consider taking only long trades. The reverse is true if you see resistance levels holding up.
Paying attention to price levels is a simple way to find a clear market bias.
This example shows major swing lows that are holding up as support, which is a sign of a bullish market.
FILTER BAD TRADES
Your trading strategy might have its own way of determining market bias. In that case, do not confuse your analysis with support and resistance. Rely on your trading strategy for a primary bias.
However, you can use support and resistance analysis to augment your trading strategy.
For instance, if your trading strategy dictates a buy, but price is right below a major resistance level, you might want to wait for a clear break-out of the resistance before entering on pullbacks.
By waiting for more price action to unfold near support and resistance levels, you can avoid low-quality trades.
TRADE ENTRIES
Look for bullish signals at support levels and bearish signals at resistance levels. This is the key to finding the best trades in any trading strategy.
This chart shows a trade from the MACD with inside bar trading strategy. The bullish inside bar was a result of support at an area of earlier price congestion. It had the makings of a high-quality trade.
TRADE EXITS
For day traders, the high and low of the previous trading session are important support and resistance levels. This example (retrace day trading setup) shows that the low of the previous session was the perfect price target for this trade.
SUPPORT & RESISTANCE – ESSENTIAL &
EFFECTIVE
Support and resistance are essential features of the price landscape. Do not navigate prices without them.
Before considering any trade, mark out the support and resistance levels. These potential zones of demand and supply will help you understand the market.
INSTANTLY IMPROVE YOUR
TRADING STRATEGY WITH
SUPPORT AND RESISTANCE
By Galen Woods in Trading Articles on January 2, 2014
What is the best way to improve your trading strategy? Use support and resistance concepts in your trading strategy.
Learn how to use support and resistance levels in your trading strategy to improve your trading results.
WHAT ARE SUPPORT AND RESISTANCE
LEVELS?
Before you learn about support and resistance, you must first understand basic demand and supply.
Demand and supply are the underlying forces of price movements. Market turns up when demand overwhelms supply and turns down when supply overcomes demand.
(Technical analysis studies recurring price patterns that result from demand and supply changes. Fundamental analysis drills into the determinants of demand and supply.)
Prices move up when demand is stronger than supply. Buyers are more eager to buy than sellers are willing to sell. So buyers will offer a higher price to entice sellers. Price rises.
Prices drop when supply is stronger than demand. Sellers are more eager to sell than buyers are willing to buy. In this case, sellers will lower their asking price until buyers are willing to buy. Prices fall.
At support levels, we expect demand to overwhelm supply. When demand is stronger than supply, price will rise. Or at least, price will stop falling at the support level.
Take note that support and resistance are not clear-cut price levels. They occur over a range of prices. However, for convenience and clarity, many technical analysts draw lines to mark out support and resistance.
Drawing lines to represent support and resistance is acceptable as long as you understand that the lines actually represent zones where the demand and supply imbalance switches.
HOW TO FIND SUPPORT AND RESISTANCE
LEVELS?
SWING HIGHS AND SWING LOWS
Swing highs and swing lows are earlier market turning points. Hence, they are natural choices for projecting support and resistance levels.
Every swing point is a potential support or resistance level. However, for effective trading, focus on major swing highs and lows.
CONGESTION AREAS
Market participants have spent a prolonged time in congestion areas. It is likely that they have formed psychological attachment or have established actual trading interest within that price range. Hence, earlier market congestion areas are reliable support and resistance levels.
Congestion areas reinforces the idea that support and resistance are zones, and not a specific price level.
If you need help finding congestion areas, price by volume charts might help.
PSYCHOLOGICAL NUMBERS
Humans attach significance to certain numbers.
Round numbers are the best examples. Round numbers always make financial
headlines. TheNatural Number Trading Strategy derives its trading edge from round numbers.
The 52-week high and low price of a security is another example of a psychologically important number.
CALCULATED SUPPORT/RESISTANCE
You can also derive support and resistance from calculated values like the moving average. They work best in trending markets.
Combining candlestick patterns with a moving average is a reliable trading method that uses moving average as support/resistance.
Fibonacci retracement is another popular method for projecting support and resistance by calculation. With a decent charting package, we can mark out retracement levels easily without manual calculation.
Identify major market swings and focus on retracement of the move by a Fibonacci ratio.
Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8% and 100%. A 100% retracement is the same as using a swing high/low as resistance/support.
The intraday trend trading strategy we reviewed uses Fibonacci retracements to find the best trades.
FLIPPING OF SUPPORT/RESISTANCE
Flipping is an important concept for support and resistance. It refers to the phenomenon of support turning into resistance or resistance turning into support.
When price breaks through a support level, it shows a shift of power from buyers to sellers. The support level then becomes a resistance level that sellers are confident of defending. The reverse is true for price breaking through resistance.
This concept is applicable regardless of the method you use to find support and resistance levels.
SUPPORT/RESISTANCE FROM HIGHER TIME-FRAME
To focus on major support and resistance levels, you can find them on higher time-frames before applying them to your trading time-frame for analysis.
For instance, you can note down the support and resistance levels from the weekly chart. Then, plot them on the daily chart to find trading opportunities.
This method keeps you focused on important support and resistance levels instead of flooding your chart with dozens of potential support and resistance levels.
HOW TO USE SUPPORT AND RESISTANCE
LEVELS IN YOUR TRADING STRATEGY?
TRADING DIRECTION
In up trends, support levels are likely to hold. In down trends, resistance levels tend to hold.
Hence, if you see that support levels are holding up, you might consider taking only long trades. The reverse is true if you see resistance levels holding up.
Paying attention to price levels is a simple way to find a clear market bias.
This example shows major swing lows that are holding up as support, which is a sign of a bullish market.
FILTER BAD TRADES
Your trading strategy might have its own way of determining market bias. In that case, do not confuse your analysis with support and resistance. Rely on your trading strategy for a primary bias.
However, you can use support and resistance analysis to augment your trading strategy.
For instance, if your trading strategy dictates a buy, but price is right below a major resistance level, you might want to wait for a clear break-out of the resistance before entering on pullbacks.
By waiting for more price action to unfold near support and resistance levels, you can avoid low-quality trades.
TRADE ENTRIES
Look for bullish signals at support levels and bearish signals at resistance levels. This is the key to finding the best trades in any trading strategy.
This chart shows a trade from the MACD with inside bar trading strategy. The bullish inside bar was a result of support at an area of earlier price congestion. It had the makings of a high-quality trade.
TRADE EXITS
For day traders, the high and low of the previous trading session are important support and resistance levels. This example (retrace day trading setup) shows that the low of the previous session was the perfect price target for this trade.
SUPPORT & RESISTANCE – ESSENTIAL &
EFFECTIVE
Support and resistance are essential features of the price landscape. Do not navigate prices without them.
Before considering any trade, mark out the support and resistance levels. These potential zones of demand and supply will help you understand the market.
RELIABLE SUPPORT AND
RESISTANCE ZONES WITH HIGH
VOLUME SIGNALS
By Galen Woods in Trading Articles on December 2, 2014
Price never moves in a straight line. Price action bounces up and down between support and resistance levels. In fact, when skilled price action traders analyse a chart, they are just looking for support and resistance zones.
We look at major support and resistance for market bias. We also make use of minor support and resistance for timing purposes.
Support and resistance is a key price action trading concept. Hence, it is not surprising to find a myriad of techniques for projecting support and resistance.
Traders seem to buy in areas of support and sell in areas of resistance. But they do not react to support and resistance because of magic. They do because they are interested in those price levels.
The best way to gauge market interest is by observing volume. When a price zone gets the interest of the market, the market trades. Volume surges.
Hence, by paying attention to volume clues, we can find reliable support and resistance areas. The easiest way to find volume-based support and resistance is to focus on climatic volume signals. While they do not occur often, you cannot miss them when they do.
What are climatic volume signals? How high is high?
Here, I will use the volume benchmark that I applied to find Anchor Bars and Exhaustion Gaps.
The benchmark is the upper Bollinger Band with a look-back setting of 233 and a displacement of 3 standard deviations. If a price bar shows volume higher than this benchmark, we will zoom in and analyse it as a potential support or resistance area.
First, find a high volume price bar, Then, mark its high and low prices. The area between is the potential support or resistance area.
Let’s take a look at the two examples below.
HIGH VOLUME SUPPORT/RESISTANCE –
SPY ETF
The top panel shows the daily price bars of SPY. The lower panel shows the volume of each day. The orange line is the Bollinger Band benchmark as described above. Look out for instances when the volume rises above the orange line.
1. These two consecutive high volume bars caught our attention.
2. Using the highest and lowest traded price of these two days, we drew a price zone. 3. As the market rose, the price zone became a potential support zone.
4. At the end of the first deep pullback down, the price zone offered perfect support to halt the market descent.
This is a textbook example. Buying when the market dipped into the support zone was a great trade with almost no adverse movement.
The next example will show that price action around a support zone is not always as neat.
HIGH VOLUME SUPPORT/RESISTANCE –
LEN
This chart shows the daily price bars of Lennar Corporation (LEN on NYSE).
1. We spotted this clear surge in volume.
2. Using the high and low of the high volume bar, we marked out a potential support/resistance zone. 3. After rising above the price zone, the market tested the support zone for five times before leaving it
alone. The fourth test was the strongest and shook most weak bulls out of their positions.
The tests of the support zone were of varying strengths. Such market movement made it difficult to make use of the support zone for trade entries. Thus, blindly buying a bounce off the support zone was not ideal. It was essential to use more specific trading setups to define our risk and reward.
TRADING WITH HIGH VOLUME SUPPORT
AND RESISTANCE ZONES
When trading with any form of support/resistance, always look out for support/resistance zones that have failed.
Generally, if the market falls sharply through a support area, it becomes invalid as a support. (You can still observe it for flip trades as the support switches into a potential resistance zone.) The same logic applies for a market rising through a resistance area with clear momentum.
A tip for day traders: fine tune your support and resistance levels with range bars instead of time-based charts. Range bars with high volume are effective intraday support and resistance levels.
High volume price zones are potential support and resistance areas. Potential is the key word here. They do not always work. Hence, you must not trade them blindly.
While looking out for high volume price zones is great for mapping the market structure, it is not a complete trading method. You should always use other trading methods to time your entry.
Suffering from whipsaws and uncontrolled risk? Learn to time your trades with a simple and effective price pattern.
ANCHOR ZONES TRADING
STRATEGY
By Galen Woods in Trading Setups on February 3, 2014
L. A. Little wrote two excellent books on trend trading. In his books, he explained a key timing concept called anchor zones, which is a very useful tool for price action traders.
In our review, we will find anchor zones and design a trading strategy around them. However, bear in mind that anchor zones are just a part of L. A. Little’s trading framework. To apply anchor zones in L. A. Little’s trend framework. you must refer to his books.
Trend Qualification and Trading: Techniques To Identify the Best Trends to Trade (Wiley Trading)
ANCHOR ZONES
To mark out anchor zones, we must first find anchor bars. Anchor bars have one or more of the following signs of extreme price activity:
Wide range Gaps
High volume
Once you find the anchors bars, you can draw the anchor zones by marking the limits of the bars. The chart below shows how to do it.
The steps are simple.
1. Find bars with extreme volume, range, or gaps. 2. These are the anchors bars.
3. Draw zones along the limits of the anchor bars and expect price to stay within the zone.
TRADING RULES – ANCHOR ZONES
LONG TRADING SETUP
1. A bullish reversal bar that tests the support anchor zone 2. Buy on break of high of reversal bar
SHORT TRADING SETUP
1. A bearish reversal bar that tests the resistance anchor zone 2. Sell on break of low of reversal bar
ANCHOR ZONES TRADING EXAMPLES
WINNING TRADE – BULLISH TRADE
The examples in L. A. Little’s books are mostly from the stock market and in the daily time-frame. However, in this trade, we used the anchor zones method on a 20-minute chart of the 6J futures on CME.
1. The extreme range and volume highlighted the anchors bars which guided us to mark out the support and resistance zones.
2. The bullish reversal bar that poked slightly below the anchor support zone is our trading signal. We placed a buy stop order on its high. Prices rose and stopped just short of the resistance zone, giving us a enough room for profit.
3. This anchor zone was very successful in containing the price movement. The red and green circles highlight other potential anchor zone trades.
LOSING TRADE – BULLISH TRADE
This is a daily chart of EBAY. It shows anchor zones that provided some support and resistance but did not lead to a profitable trade.
1. Taking our cue from the volume and range plots, we marked out the anchor zones. 2. Prices fell quickly to the support zone. It held up with a bullish outside bar and inside bar.
However, neither bullish patterns had follow-through.
3. Finally, a bullish reversal bar formed on the support zone, and we bought as price broke above it. However, the trade failed swiftly as price fell through the anchor zone to test an earlier swing low.
REVIEW – ANCHOR ZONES TRADING
STRATEGY
Price action often exhaust themselves with climatic moves. Anchors bars include gaps, wide range, and high volume. These are also signs of climatic moves. Hence, anchor bars are exhaustive moves.
Marking out support and resistance zones with anchor bars is a superb trading method. It integrates price and volume to find key price ranges that work well to contain prices.
This concept of anchoring prices with exhaustive moves also work in day trading. The high and/or low of the each trading session is often formed within the first trading hour. The first hour of the trading day usually has wide range and high volume. Hence, it serves as an anchor for the rest of the trading session. Morning reversal trades and opening range break-out trades work on the same premise.
Our trading rules focus on reversal bars as entry signals for simplicity. In fact, you can look out for any candlestick pattern to time the trade.
More experienced traders can even enter with limit orders slightly beyond the anchor zones. Using limit orders will result in minimal adverse price movement in successful trades. The stop-loss is tight and the reward to risk ratio is excellent. However, you must have ironclad discipline to exit without hesitation.
Read: Trading Ranges with Gimmee Bars
If you find this anchor zone concept effective, you should see how it works with L. A. Little’s trading framework in his highly reviewed books.
YOU ARE HERE: HOME / TRADING ARTICLES / RELIABLE SUPPORT AND RESISTANCE ZONES WITH HIGH VOLUME SIGNALS
RELIABLE SUPPORT AND
RESISTANCE ZONES WITH HIGH
VOLUME SIGNALS
By Galen Woods in Trading Articles on December 2, 2014
Price never moves in a straight line. Price action bounces up and down between support and resistance levels. In fact, when skilled price action traders analyse a chart, they are just looking for support and resistance zones.
We look at major support and resistance for market bias. We also make use of minor support and resistance for timing purposes.
Support and resistance is a key price action trading concept. Hence, it is not surprising to find a myriad of techniques for projecting support and resistance.
Traders seem to buy in areas of support and sell in areas of resistance. But they do not react to support and resistance because of magic. They do because they are interested in those price levels.
The best way to gauge market interest is by observing volume. When a price zone gets the interest of the market, the market trades. Volume surges.
Hence, by paying attention to volume clues, we can find reliable support and resistance areas. The easiest way to find volume-based support and resistance is to focus on climatic volume signals. While they do not occur often, you cannot miss them when they do.
What are climatic volume signals? How high is high?
Here, I will use the volume benchmark that I applied to find Anchor Bars and Exhaustion Gaps.
The benchmark is the upper Bollinger Band with a look-back setting of 233 and a displacement of 3 standard deviations. If a price bar shows volume higher than this benchmark, we will zoom in and analyse it as a potential support or resistance area.
First, find a high volume price bar, Then, mark its high and low prices. The area between is the potential support or resistance area.
Let’s take a look at the two examples below.
HIGH VOLUME SUPPORT/RESISTANCE –
SPY ETF
The top panel shows the daily price bars of SPY. The lower panel shows the volume of each day. The orange line is the Bollinger Band benchmark as described above. Look out for instances when the volume rises above the orange line.
1. These two consecutive high volume bars caught our attention.
2. Using the highest and lowest traded price of these two days, we drew a price zone. 3. As the market rose, the price zone became a potential support zone.
4. At the end of the first deep pullback down, the price zone offered perfect support to halt the market descent.
This is a textbook example. Buying when the market dipped into the support zone was a great trade with almost no adverse movement.
HIGH VOLUME SUPPORT/RESISTANCE –
LEN
This chart shows the daily price bars of Lennar Corporation (LEN on NYSE). 1. We spotted this clear surge in volume.
2. Using the high and low of the high volume bar, we marked out a potential support/resistance zone.
3. After rising above the price zone, the market tested the support zone for five times before leaving it alone. The fourth test was the strongest and shook most weak bulls out of their positions. The tests of the support zone were of varying strengths. Such market movement made it difficult to make use of the support zone for trade entries. Thus, blindly buying a bounce off the support zone was not ideal. It was essential to use more specific trading setups to define our risk and reward.
TRADING WITH HIGH VOLUME SUPPORT
AND RESISTANCE ZONES
When trading with any form of support/resistance, always look out for support/resistance zones that have failed.
Generally, if the market falls sharply through a support area, it becomes invalid as a support. (You can still observe it for flip trades as the support switches into a potential resistance zone.) The same logic applies for a market rising through a resistance area with clear momentum. A tip for day traders: fine tune your support and resistance levels with range bars instead of time-based charts. Range bars with high volume are effective intraday support and resistance levels.
High volume price zones are potential support and resistance areas. Potential is the key word here. They do not always work. Hence, you must not trade them blindly.
While looking out for high volume price zones is great for mapping the market structure, it is not a complete trading method. You should always use other trading methods to time your entry.
Suffering from whipsaws and uncontrolled risk? Learn to time your trades with a simple and effective price pattern.
HOW TO IDENTIFY DEMAND AND
SUPPLY USING PRICE ACTION
By Galen Woods in Trading Articles on June 5, 2015
Want to find demand and supply in the market? Just look at the market depth screen and you will see orders to buy and sell at different prices. Those numbers show demand and supply.
That’s all. You’ve found demand and supply. What can you do with it? Nothing. Now, think again. Do you really want to find demand and supply?
In a liquid market, there is constant supply and demand. People are always willing to buy and sell at different prices. Demand and supply are everywhere. There is no need to find them. What you really want to find are the price zones where supply overwhelms demand and where demand overwhelms supply.
The former is known as resistance. When the market bumps into resistance, price will drop. Then, you can make money by shorting the market.
The latter is market support. With the support of demand, price will rise. Then, you can profit from a long position.
In a nutshell, we want to find market turning points, and not merely demand and supply. Follow the three steps below to find and trade these profitable turning points.
1. FOCUS ON A PRICE LEVEL (ZONE)
It’s difficult to analyze the market without a focal point. If you look for turning points at every price level, you will only find confusion.
How do you know which price level to focus on? Which price levels are potential market turning points?
There are many ways to find potential turning points. You can use swing pivots, calculated pivot points, Fibonacci levels, and volume signals. Learn about these methods and make use of those that make sense to you.
EXAMPLE
In this example, I focus on a valid swing pivot. (The concept of a valid swing pivot is explained in myprice action course. Essentially, it is a form of major market pivot.)
The ES 5-minute chart above shows a valid swing low. Pay attention to this price zone to find out if demand prevails.
2. OBSERVE WHAT HAPPENED (HAPPENS)
AT THE POTENTIAL SUPPORT/RESISTANCE
SIGNS OF STRONG DEMAND
When the market tests a potential support, look out for: Bullish price pattern
Inability to clear below the support
Increased volume
Congestion
SIGNS OF STRONG SUPPLY
When the market tests a potential resistance, look out for: Bearish price pattern
Increased volume
Congestion
Look for these price action signals in the past, as well as in real-time price action. The more signs you see, the more likely you’ve found a true support/resistance zone.
EXAMPLE
Let’s take a closer look at the same ES 5-minute chart to check the price action.
1. Volume increased as the market dipped into the price zone. It was a clue of a demand surge. 2. Bullish price patterns formed as the market tested the support zone. (Marubozu and Outside
Bar)
3. It was clear that the market had difficulty closing within or below the support zone.
These signs confirmed that demand would likely overwhelm supply in the indicated price zone.
3. LIMIT YOUR RISK
Once you’ve found a potential support or resistance level, remember the word “potential”. It is a tendency and not a guarantee.
Hence, you should limit your risk when you trade supply and demand zones. There are two trading approaches to do so.
METHOD ONE – DEMAND CONFIRMATION
Let price show you the way. Look for price patterns. Then, use stop orders to enter as the market confirms your opinion.
You will enter late, but you will save yourself from many bad trades. The main drawback of this strategy is that you will enter at a worse price. Hence, use this strategy only when you expect significant profit potential. Otherwise, the reward-to-risk ratio is too low.
METHOD TWO – TRADE AGGRESSIVELY
Get in early (without confirmation) with a tight stop-loss and a conservative target. In this case, use a limit order placed within the support/resistance zone.
This strategy is ideal when you are:
Confident of the demand and supply conditions;
But are uncertain of how far the market would go.
EXAMPLE
In our ES 5-minute example, the support zone looked reliable. Hence, we were confident that demand would stop the market decline.
However, given that the market has been falling, long positions were against the recent trend. It was unwise to set ambitious profit targets.
A consistent stop-loss and target of 2 points will work for both trades. It produced two swift and high probability scalps. (The stop-loss and target depends on the market volatility.)
USE PRICE ACTION TO UNDERSTAND HOW
DEMAND AND SUPPLY INTERACTS
Remember that you are anticipating the strength of demand and supply. We are interested in their interaction.
Will demand conquer supply at this price level?
Will supply overwhelm demand at this price level?
What does this (series of) price bar(s) tell me about demand and supply?
These are the questions you want to think about as you go through the three steps above. As our example showed, the market context is crucial. It helps you to tailor your trading approach to the market.
Hence, don’t focus on a simplistic definition of support and resistance. Spend your effort in studying price action clues to decipher demand and supply forces.
Read more about Price Action Trading, Support And Resistance, Volume
COMMENTS
1. HS says
October 23, 2015 at 10:45 PM
After reading this article, I still have no clues about supply and demand. How should one determining it? Is it by engulfing candlestick?
Reply
o Galen Woods says
October 26, 2015 at 12:03 PM
As a start, you can use swing pivots, calculated pivot points, Fibonacci levels, and volume signals to find potential supply and demand price zones. Then, to confirm that supply or demand is indeed present in those zones, you can look out for price patterns (engulfing falls under this), rejections, volume surges, and price congestion.
Gauging Support And
Resistance With Price By
Volume
By Justin Kuepper
Many say that charting is nothing more than predicting the direction of a price between significant support and resistance levels. We know that a support level is a price level which a stock has had difficulty falling below. This is where a lot of buyers tend to enter the stock. Similarly, we know that resistance is a price level above which a stock has difficulty climbing. This is where a lot of buyers take profits and shorts enter. Typically, a stock's price will range between these levels until it breaks out or breaks down. Hundreds of different methods can be used to locate these areas of support and resistance, but one of the most underrated methods is simply using price by volume (PBV) charts. In this article, we explain what PBV charts are and explore techniques that you can use to make effective trades using these charts. (For additional reading on volume, see Volume
Oscillator Confirms Price Movements, Volume Rate of Change and Gauging The Market's Psychological State.)
Trendlines, chart patterns, pivot points, Fibonacci lines and Gann lines are among the most popular methods used to identify areas of support and resistance. But the less commonly used PBV charts, which illustrate volume using a vertical volume histogram, can be invaluable when determining not only the location of key support and resistance levels, but also the strength of these levels. (For further reading, see Support And Resistance Zones - Part 1 and Part 2.)
What Are PBV Charts?
A price by volume chart is simply the standard volume histogram reapplied to price instead of time (price is seen on the Y axis and time on the X axis). So, instead of being able to determine when a stock is going in and out of favor (indicated by increasing volume levels over time), PBV enables you to determine the level of buying or selling interest at a given price level. PBV charts can be created in many different charting applications, as well as by using free online charting services from websites like BigCharts.com and StockCharts.com. Using PBV Charts
PBV charts are relatively easy to use and understand. There are three major elements involved:
Volume strength indicates the amount of shares that traded at the given price level. This is indicated by the horizontal length of the PBV histogram. Volume type refers to the number of shares sold compared to the number of shares bought. This is indicated by the two different colors seen on each bar.
Successful reactions or tests means the number of times a stock successfully tests and "bounces off" a given level.
Together, these three factors will allow you to determine the strength of a particular price level. Once you have a good idea of price strength, you can combine this information with trendlines and other studies to determine support and resistance levels, find support bases and even play gaps.
Finding Support Bases
trend, or reversing. To determine when a stock is basing, simply follow these steps:
1. Draw two parallel, horizontal lines that connect parallel highs and lows in a trading range after a trending move. 2. Then, use the PBV histogram to see if these parallel lines are located near key price levels.
3. Finally, note the buying or selling pressure (colors) as well as the total volume to determine in which direction a breakout is likely to occur. Figure 1 shows Hudson City Bancorp (HCBK) along with the price by volume
histogram. Looking at this chart, we can see that the longer blue bars indicate buying pressure or support, while a longer red bar indicates selling pressure or resistance. Meanwhile, the larger overall bar indicates that that particular price level is of interest to traders. In this case, we note that $12.50 appears to be a level at which we can watch for a breakout to the upside.
Source: StockCharts.com Figure 1
Locating Support and Resistance Levels
Support and resistance levels are simply areas beyond which the price has difficulty moving due to large buying or selling interests. To determine areas of support or resistance, simply do the following:
1. Identify areas where the PBV histogram shows significant buying or selling interest. 2. Determine whether these large interests are buying or selling interests.
Let's take a look at Google (GOOG) for an example:
Source: StockCharts.com Figure 2
Trending between these support and resistance levels should be immediately apparent. These areas are known as "soft areas", where only short volume bars exist between two long bars. One common strategy is to buy and sell based on the trends between these "soft areas". In the chart for Google (Figure 2), for example, we'd look to short GOOG when it breaks Support 1 and cover when it hits Support 2.
Playing Gaps
Gaps occur when an asset's price rapidly moves from one point to another, creating a visible gap or break between prices in the chart. You can use PBV charts to help predict when a gapping stock will find support simply by looking for an area where there was a lot of prior interest. Also, gaps themselves can
produce areas of future support and/or resistance, which can be reinforced by the PBV histogram. Let's take a look at a few examples:
Source: StockCharts.com Figure 3
In the case of DHB Industries (Figure 3), a PBV trader would look to buy a breakout from Resistance 2 and sell when Resistance 1 is reached. Notice that the gap down creates an area of very little resistance to upward movement - this tells us that it is likely that the second target will be reached.
Source: StockCharts.com Figure 4
In the case of Elan Corp. (Figure 4), we can see that a trader who bought on a break above $7.60 (the long PBV bar) would have already realized a gain of nearly 100%. Notice that once the key resistance was broken, there was very little resistance to the upside.
Clearly, PBV can be extremely useful when combined with gaps if you are attempting to buy rebounds or retracements after gaps occur. (To learn more, see Playing The Gap and Retracement Or Reversal: Know The Difference.) Conclusion
PBV charts can be an invaluable tool in your stock analysis arsenal. When you combine it with other methods such as trendline analysis and Fibonacci, it is easy to see how much additional insight can be gained from this charting method. Here are some key points to remember:
The first color represents volume on days when the price moved higher.
The second color represents volume on days when the price moved lower.
When one color of the bar is significantly longer than the other, strong support or resistance is present.
Horizontal trendlines connect the top of the PBV bar for resistance and the bottom of the PBV bar for support.
PBV bars are used for support and resistance levels, trading bases and gap areas. Note: This article was written with the help of Cal Stanke, co-founder of ChartSetups.com, where he uses PBV analysis extensively in his own research.
Read more: Gauging Support And Resistance With Price By Volume |
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Playing The Gap
By Justin Kuepper
Gaps are areas on a chart where the price of a stock (or another financial instrument) moves sharply up or down, with little or no trading in between. As a result, the asset's chart shows a "gap" in the normal price pattern. The
enterprising trader can interpret and exploit these gaps for profit. This article will help you understand how and why gaps occur, and how you can use them to make profitable trades.
Gap Basics
Gaps occur because of underlying fundamental or technical factors. For
example, if a company's earnings are much higher than expected, the company's stock may gap up the next day. This means that the stock price opened higher than it closed the day before, thereby leaving a gap. In the forex market, it is not uncommon for a report to generate so much buzz that it widens the bid and ask spread to a point where a significant gap can be seen. Similarly, a stock breaking a new high in the current session may open higher in the next session,
thus gapping up for technical reasons. Gaps can be classified into four groups:
Breakaway gaps are those that occur at the end of a price pattern and signal the beginning of a new trend.
Exhaustion gaps occur near the end of a price pattern and signal a final attempt to hit new highs or lows.
Common gaps are those that cannot be placed in a price pattern - they simply represent an area where the price has "gapped."
Continuation gaps occur in the middle of a price pattern and signal a rush of buyers or sellers who share a common belief in the underlying stock's future direction.
To Fill or Not to Fill
When someone says that a gap has been "filled," that means that the price has moved back to the original pre-gap level. These fills are quite common and occur because of the following:
Irrational Exuberance: The initial spike may have been overly optimistic or pessimistic, therefore inviting a correction.
Technical Resistance: When a price moves up or down sharply, it doesn't leave behind any support or resistance.
Price Pattern: Price patterns are used to classify gaps, and can tell you if a gap will be filled or not. Exhaustion gaps are typically the most likely to be filled because they signal the end of a price trend, while continuation and breakaway gaps are significantly less likely to be filled, since they are used to confirm the direction of the current trend.
When gaps are filled within the same trading day on which they occur, this is referred to as fading. For example, let's say a company announces
great earnings per share for this quarter, and it gaps up at open (meaning it
opened significantly higher than its previous close). Now let's say that, as the day progresses, people realize that the cash flow statement shows some
weaknesses, so they start selling. Eventually, the price hits yesterday's close, and the gap is filled. Many day traders use this strategy during earnings
season or at other times when irrational exuberance is at a high. SEE: The Madness Of Crowds
How to Play the Gaps
There are many ways to take advantage of these gaps, with a few more popular strategies. Some traders will buy when fundamental or technical factors favor a gap on the next trading day. For example, they'll buy a stock after-hours when a positive earnings report is released, hoping for a gap up on the following trading day. Traders might also buy or sell into highly liquid or illiquid positions at the beginning of a price movement, hoping for a good fill and a continued trend. For
example, they may buy a currency when it is gapping up very quickly on low liquidity and there is no significant resistance overhead.
Some traders will fade gaps in the opposite direction once a high or low point has been determined (often through other forms of technical analysis). For example, if a stock gaps up on some speculative report, experienced traders may fade the gap by shorting the stock. Lastly, traders might buy when the price level reaches the prior support after the gap has been filled. An example of this strategy is outlined below.
Here are the key things you will want to remember when trading gaps:
Once a stock has started to fill the gap, it will rarely stop, because there is often no immediate support or resistance.
Exhaustion gaps and continuation gaps predict the price moving in two different directions - be sure that you correctly classify the gap you are going to play.
Retail investors are the ones who usually exhibit irrational exuberance; however, institutional investors may play along to help their portfolios - so be careful when using this indicator, and make sure to wait for the price to start to break before taking a position.
Be sure to watch the volume. High volume should be present in breakaway gaps, while low volume should occur in exhaustion gaps.
Example
To tie these ideas together, let's look at a basic gap trading system developed for the forex market. This system uses gaps in order to predict retracements to a prior price. Here are the rules:
1. The trade must always be in the overall direction of the price (check hourly charts).
2. The currency must gap significantly above or below a key resistance level on the 30-minute charts.
3. The price must retrace to the original resistance level. This will indicate that the gap has been filled, and the price has returned to prior resistance turned support.
4. There must be a candle signifying a continuation of the price in the direction of the gap. This will help ensure that the support will remain intact.
Note that because the forex market is a 24-hour market (it is open 24 hours a day from 5pm EST on Sunday until 4pm EST Friday), gaps in the forex market appear on a chart as large candles. These large candles often occur because of the release of a report that causes sharp price movements with little to no
liquidity. In the forex market, the only visible gaps that occur on a chart happen when the market opens after the weekend.
Let's look at an example of this system in action:
Figure 1 - The large candlestick identified by the left arrow on
this GBP/USD chart is an example of a gap found in the forex market. This does not look like a regular gap, but the lack of liquidity between the prices makes it so. Notice how these levels act as strong levels ofsupport and resistance.
We can see in Figure 1 that the price gapped up above some consolidation resistance, retraced and filled the gap, and finally, resumed its way up before heading back down. We can see that there is little support below the gap, until the prior support (where we buy). A trader could also short the currency on the way down to this point, if he or she were able to identify a top.
The Bottom Line
Those who study the underlying factors behind a gap and correctly identify its type, can often trade with a high probability of success. However, there is always a risk that a trade can go bad. You can avoid this, firstly, by watching the real-time electronic communication network (ECN) and volume. This will give you an idea of where different open trades stand. If you see high-volume resistance preventing a gap from being filled, then double check the premise of your trade and consider not trading it if you are not completely certain that it is correct. Second, be sure that the rally is over. Irrational exuberance is not necessarily immediately corrected by the market. Sometimes stocks can rise for years at extremely high valuations and trade high on rumors, without a correction. Be sure to wait for declining and negative volume before taking a position.Lastly, always be sure to use a stop-loss when trading. It is best to place the stop-loss point below key support levels, or at a set percentage, such as -8%.
Remember, gaps are risky (due to low liquidity and high volatility), but if properly traded, they offer opportunities for quick profits.
Read more: Playing The Gap |
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Retracement Or Reversal:
Know The Difference
By Justin Kuepper
Most of us have wondered, at some point, whether a decline in the price of a stock we're holding is long term or a mere market hiccup. Some of us have sold our stock in such a situation, only to see it rise to new highs just days later. This is a frustrating and all too common scenario, but it can be avoided if you know how to identify and trade retracements properly.
What Are Retracements?
Retracements are temporary price reversals that take place within a larger trend. The key here is that these price reversals are temporary, and do not indicate a change in the larger trend.
Figure 1: An example of retracements in the price action of a particular stock.
Notice that despite the retracements, the long-term trend shown in this chart is still intact - that is, the price of the stock is still going up.
The Importance of Recognizing Retracements
It is important to know how to distinguish a retracement from a reversal. There are several key differences between the two that you should take into account when classifying a price movement:
Factor Retracement Reversal
Volume Profit taking by retail traders (small block trades)
Institutional selling (large block trades)
Money Flow Buying interest during decline
Very little buying interest
Chart Patterns Few, if any, reversal patterns - usually limited to candles
Several reversal patterns - usually chart patterns (double top, etc.)
Short Interest* No change in short interest Increasing short interest Time Frame Short-term reversal, lasting
no longer than one to two weeks
Long-term reversal, lasting longer than a couple of weeks
Fundamentals No change in fundamentals Change or speculation of change in fundamentals Recent Activity Usually occurs right after
large gains
Can happen at any time, even during otherwise regular trading
Candlesticks "Indecision" candles - these typically have long tops and bottoms (spinning tops, etc.)
Reversal candles - these include engulfings, soldiers and other similar patterns Figure 2 - *Note that short interest is delayed when reported, so it can be difficult to tell for certain depending on your time frame.
So, why is recognizing retracements so important? Whenever a price reverses, most traders and investors are faced with a tough decision. They have three options:
1. Hold throughout the sell-off, which could result in large losses if the retracement turns out to be a larger trend reversal.
2. Sell and re-buy if the price recovers, which will definitely result in money wasted on commissions and spreads. This may also result in a missed opportunity if the price recovers sharply.
3. Sell permanently, which could result in a missed opportunity if the price recovers.
By properly identifying the movement as either a retracement or a reversal, you can reduce cost, limit loss and preserve gains.
Determining Scope
Once you know how to identify retracements, you can learn how to determine their scope. The following are the most popular tools used to do this:
