Support and resistance levels are essential tools that I rely on to help formulate my trade entries, exits, and get an overall feel for market sentiment.
And yet, so many traders can get it wrong!
They’ll sell at resistance levels and buy at support—that’s the how to lose money quick strategy.
And a school of thought that I don’t prescribe too.
What if I told you that support… is resistance… and resistance… is support?
Prepare to get your mind blown…
Here’s what you’ll learn:
- Common Lies about support and resistance lines
- Pros/Cons of traditional support and resistance trading
- Pitfalls that most traders are not aware of when trading this pattern
- How to determine the correct entry and stop prices to maximize your risk vs return
I’m sorry, but you have been lied to this entire time…
Lie 1: Support and Resistance lines are some of the strongest signals a trader can look for.
Truth: In actuality, the more times a support and resistance line is tested, the weaker it becomes! This is because of exhaustion and the ability for traders to continue to hold stock over time.
Remember… day traders don’t want to be swing traders! Keeping price at a level too long will cause the buyers to walk away (causing a weak support line)!
As we can see in this chart, the support was not held.
That is because it took too long for the trade to unfold, causing “weakness” in the support levels.
The daytraders got tired of waiting for the price to bounce, and the sellers were able to push the price lower.
Without a balanced Supply and Demand at the Support zone, the Suppliers (Sellers) were able to win that battle. With buy orders rapidly being filled, who is left to buy? Nobody!
Lie 2: Support and Resistance are lines on your chart.
Truth: It’s a Zone, not a Line! Let’s be realistic. Nothing is a line in the sand.
That is the same for buying your favorite sneakers to buying stock.
Just because you don’t want to spend over $100 on a fresh pair of kicks doesn’t mean you will turn away a lit basketball sneaker because it costs $125. The same goes for trading!
Alright, this means that every level has some wiggle room and “Overshooting” or “Undershooting” your price is common.
In this example, the market came close to my SR line, but not close enough. It undershot the support price level.
It then reversed back into the opposite direction. And you may have missed the trade because you were waiting for the market to test your exact support (or resistance) level.
The stock still bounced at support just as we expected! Looks to be a great trade.
So how do we solve this problem and why does this happen in the first place?
You need to understand that there are two groups involved :
- Deal Traders
- Steal Traders
The “Deal” traders are the guys who hunt for the best possible price they can have. The “Deal” traders (who are Cheapos) want to get the best possible deal, so they place orders at or under the support level.
The “Steal” traders believe that they are going to miss out on a trade and rationalize that the current price is cheap. “Steal” traders (who also suffer from FOMO) tend to buy the stock the minute it comes close to a SR area.
Here is the thing:
You have no idea who is in control, the Buyers or Sellers.
Therefore, this causes Support and Resistance lines to be areas on your chart.
Lie 3: Support and Resistance are the worst place to put your stop loss
Truth: Don’t believe the tinfoil-hat man. Stop hunters don’t exist!
Do you honestly believe that a little gremlin is hiding out in your charts, looking for traders to place stops that they can “Steal”.
Don’t be fooled by that hype… Because support and resistance are some of the best spots for your stop losses!
Let’s take a look at the SPY daily chart quickly.
There are 2 key things to pay attention to here:
- The risk vs reward is substantially in your favor. There is about $20 of profit, and $4 of risk by taking this trade. Show me the money!
- The stop loss right above your resistance line was the ideal stop price as trend continued higher.
Why are Support and Resistance lines a great area for placing your stops at?
That’s because if either the buyers or sellers take control, it’s a hot zone for sudden price movement.
If you are on the correct side of the trade you are in a great position to make massive risk vs reward gains!
If you are on the wrong side of the trade, you only risked a little to make a lot.
How to prevent yourself from being “trapped” when a Support or Resistance price fails
It’s important to remember :
- Support tends to break in a downtrend
- Resistance tends to break in an uptrend
Support and Resistance trading attracts many key players. Those looking for a reversal in stock price, and those looking for a momentum breakout in stock price.
As I said earlier, traders lose the most money when they buy at support and sell at resistance. But wait… didn’t I just say that is some of the best risk to reward areas to look for?
Broken resistance becomes support.
Is your mind blown yet?
Check out this example:
We broke through resistance… Now it’s time for that area to act as support!
Trading is a zero sum game after all. In order to win, someone must lose.
So now you are armed with the tools to get out there and start trading Support and Resistance lines correctly!
We have identified and learned some key concepts. Many of which have been taught to you incorrectly!
With these few tricks and treats, you are now able to:
Uncover the lies behind support and resistance lines
Understand the benefits of support and resistance trading
Common pitfalls most traders are not aware of
How to determine the correct entry and stop prices