Way of the turtle

76
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Way of the Turtle
KC: Coffee-CSCE
95
Nov 2000
Oct 2000
Sep 2000
Aug 2
00
0
Jul 2
00
0
Jun 2
00
0
May 2000
100
105
110
115
120
125
Support 1
Resistance 1
Resistance 2
Resistance 3
Support 2
Support 3
Support 4
Figure 6-1
Support and Resistance Levels 
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traders and longer-term position traders alike. As the price descends
back to the range of $1.15, over the days after the high at about
$1.23, traders continue to think in terms of the previous but still
recent $1.13 low. At $1.15 they will judge the price as low but not
too low on the basis of a comparison with that anchor price at $1.13.
Recency bias is the tendency for people to place greater impor-
tance on more recent data and experience. Since the low at $1.13
was recent, it will count more in a trader’s evaluation of the cur-
rent price than will other previous lows. That low will have a
greater meaning to the market participant because of this bias. How
does this affect the support and resistance phenomenon?
Imagine that you are a trader who wants to buy coffee. When
the price first went to $1.13, you might have wished or hoped that
it would go even lower and therefore might not have purchased
coffee at that price. As the price climbed to $1.23 over the next sev-
eral days, you would have been very unhappy that you did not buy
any coffee below $1.15 because you are now anchoring on that
recent $1.13 low which becomes the basis for a more concrete
sense of a “low” price. Thus, when the price drops below $1.15 a
few days later, you will be much more likely to buy even though
the price is the same as it was the last time the price was there a
few days earlier. The effect of anchoring and the recency bias will
cause you to consider any price below $1.15 as reasonably low and
therefore a good price at which to buy. Since many market partic-
ipants similarly consider a price below $1.15 as good, any pause in
the price movement below that price probably will result in more
buyers coming into the market. This influx of new buyers at points
of support creates a tendency for market prices to bounce off the
price levels of previous highs and lows. 
Falling Off the Edge
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77

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The perception of most traders that support and resistance is a
real phenomenon adds to the reality of its existence because the
market behavior of those who believe in it by itself reinforces that
phenomenon. If many traders believe that there will be significant
buying when a price drops to a certain level, they will be more
inclined to believe that the price will rise once it reaches that level.
This belief in and of itself will reduce their willingness to sell at or
near that price since they will prefer to sell later, after the price has
risen—because of the effect of support at the price. The belief in
support and resistance causes it to become a self-fulfilling prophecy.
The disposition effect is the tendency for traders to want to lock
in profits rather than let winning trades get larger. Traders’ fear of
losing profits grows stronger as those profits rise. How does this
affect support and resistance?
Imagine that you were a trader who bought coffee in early
August at 102 just after the end of the area labeled “Support 2” in
Figure 6-1. When the price rose to 114 over the next several days,
you probably would not have sold because the price moved so
quickly in your favor that you would have believed that it might go
as high as 120 or 125. Subsequently, when the price dropped to
105, you found yourself wishing that you had sold it over 110. The
recent high would have had you thinking, “If the price gets over
114 again, I am going to sell this time.”
Thus, when the price does in fact go back up to that level, you
want to lock in your profits and sell at that time. There probably
will be many others in a similar position who also will want to sell
when the price again approaches those recent highs (the area
labeled “Resistance 2”). This creates a natural barrier at that price
because many traders will want to sell at what they consider a high