Praise for Trading from Your Gut

FIGURE 4.4
Cycles that are not uniform 
Support and Resistance: Push Me,
Pull You
Support and resistance is one of the most important concepts in
market structure. Changes in cycle direction because of the
crossover between buyer and seller anxiety often take place near
support and resistance levels. Consider Figure 4.5.
Horizontal support and resistance always depends on an initial
anchor point, a point on the chart that during subsequent trading
days stands out as a significant visual high or low. In Figure 4.5, the
point labeled A, where the price of Cisco rallied to $20 per share at
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the end of April, is an anchor point for the subsequent resistance.
This price of $20 defines the resistance level. An anchor point takes
on meaning only after at least a few days have passed and its price
has not been exceeded. The point defined at A is significant because
$20 is the highest trading level for several trading months.
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Resistance
Support
A
B
C
D
E
F
G
CSCO (Cisco Systems, Inc.) Nasdaq GS
2-Jul-2009
Op 18.27 Hi 18.51 Lo 18.06
Cl 18.17
Vol 52.9M
Chg +0.04 (+0.22%) 
CSCO (Daily) 
Mar
9
16
23
Apr 6
13
20
27 May
11
18
26 Jun
Jul
8
15
22
6
20.0
19.5
19.0
18.5
18.0
17.5
17.0
16.5
16.0
15.5
15.0
14.5
14.0
FIGURE 4.5
Support and resistance 
Subsequent price points B, E, and F represent changes in cycle
direction because of their proximity to the resistance level of $20
defined by the anchor point at A. 
At point B, as the price nears $20 after having dropped to $19
twice, increased selling pressure will occur. Many sellers who were
hoping for a better price when the market first approached $20 at A
will have had their hopes tempered by the subsequent price drop. So
when the price reaches that level again, they will be more anxious to
sell than they were when it first hit that level. Furthermore, because
the price of $20 has not been exceeded during the intervening four
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days, it will now seem like a high price to both buyers and sellers.
Buyers will be less willing to buy at this high price and sellers will be
more willing to sell.
The combination of these two factors creates a natural barrier to
the price going higher—a resistance level near $20. The price is
more likely to reverse course near resistance levels. Resistance lev-
els also serve as a natural place for an up cycle to change into a down
cycle. As the price nears the resistance, buyer anxiety drops and
seller anxiety climbs until the sellers become more anxious to sell.
They are then more willing to place market orders. This generally
results in at least a temporary drop in price.
Resistance might last for only one day or for a few days. The
price might not quite reach the level of resistance before it has an
effect. It is not uncommon for the price to come close but not
exceed the price. Consider point E. After having dropped below
$18, the price rises again in late May to a high point near $19.80. At
that point, it begins to falter and drops back again to near $19. The
$20 price offered resistance at E even though the price did not quite
reach $20.
Other times, resistance is exceeded by a small amount during
several days, but the price can’t seem to break out of the level
defined by the resistance. Notice point F. The price exceeds $20 for
a couple days but doesn’t make it higher than about $20.25. It is not
uncommon for resistance to have this effect. The resistance level is
exceeded, but only by a little bit. Buyers are not anxious enough to
drive the price higher, and sellers are anxious that they will not see
this price again, so they panic first.
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Now consider support. At point C on the chart, the price has
established a low at $17.80. Subsequent to this point, the price rises
to a level of about $19.35 and then descends again to just below the
price at point C, at about $17.75, where it finds support. Buyers
become more anxious than sellers at this point. They consider
$17.75–$17.80 to be a low price, and they are more willing to place
market orders, so the price rises. Other potential buyers don’t want
to miss out on the low prices, so they join them. This causes the
price to rise further.
A very significant part of the reason prices appear to “bounce”
off support and resistance levels is that many traders have observed
this effect and expect to see it in the future. Therefore, support and
resistance is partly a self-fulfilling prophecy. Traders buy at support
levels in expectation of the rise in prices due to the support itself.
Traders sell at resistance levels in expectation of the decline in
prices due to the resistance itself. When multiplied, these effects
make support and resistance one of the most powerful concepts in
trading. The behavior of market participants reinforces the effects
themselves.
Finally, notice the effect of the same support level almost two
months later when the price hits $17.85 after having climbed to
more than $20 in the intervening period. Once again, a bounce
occurs at G, where the price climbs to $18.85. This sort of bounce is
very common. Even if the price goes down during the subsequent
day or two, a temporary bounce at support and resistance levels is
one of the most reliable concepts in trading.
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From the Library of Daniel Johnson

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