Where to draw Horizontal Lines and why? Part 3

Using reaction at price levels to determine price direction.

Support and Resistance Trading.  Part 3.  

Part 1 of this case study showed how I choose support and resistance price levels using red horizontal lines.  Part 2 of the case study I discussed how I can use the levels to determine trading direction, where to enter, place limits and stops.  Here in part 3, I will continue to discuss the clues provided by price action for USDCAD during Q1 2013.

Once price chooses a direction, I must remain focused and watch closely for clues suggesting the move will continue, stop and or reverse.  Stop and or stalling, at a level, in itself, is not enough to suggest the move is over.  The clues of continuation or reversals come from price behaviour at structure levels: making or failing to make new HH or LL, putting in new HL or LH.  All of this helps to define the trend direction and it’s strengths.  In addition, I like to use Fibonacci retracement and extension levels. 

Note: 1.00000 is a psychological big number, it can be expected to see natural resistance around it.  So too is 1.01000 but to a lesser extent.  Careful with trading at these levels and be wary of false breaks though once a side is chosen the moves can be significant.

The chart below brings in my use of Fibonacci retracement levels when they align with horizontal lines. 

The second chart brings in EMA lines, I like to look at the charts in this order.  First identify levels, then bring in Fibonacci levels and then EMA lines. 

 

Where to draw Horizontal Lines and why? Part 2

Identifying Support and Resistance Levels.

Case Study: USDCAD 2013 Q1.

PART 2.

How I draw, qualify and use horizontal lines.  USDCAD Case Study Jan 2013, Q1.

To begin, I will identify the key horizontal lines from October – December 2012, Q4.  Then use these to read and understand why price moved as it did during January to March 2013.  Here, I am using quarterly segments as forex trading requires patience in regards to time.

  • The first chart identifies 4 lines: the periods high, low, and it’s structure high and low.
  • Chart 1 summary:
    • High 1.00582  Low .97364.
    • Early in the quarter structure high (SH) resistance is about .98800 which then becomes the structure low (SL) support in early November.
      • This suggest below the line sellers are stronger than buyers and therefore affect price more.  When price level .98800 is broken, to the upside, it suggest sellers no longer find this price level attractive and sell less, if at all.
      • After price broke above .98800 it suggest buyers are outnumbering sellers.
      • After trading above .98800 price then came back down to  it, again.  It would be highly probable to expect buyers to outnumbered sellers here and price should move back up.  That is exactly what happened and a new HH was set in Middle of November.
    • Later in the quarter, early December, the SL at .98800 is broken, as price came back to it, buyers were not liking this price level and therefore price continued further down establishing a new structure low at about .98200

I will now use these identified levels from chart 1 to read and interpret Q1 2013, chart 2.

  • Chart 2 has two red horizontal red lines which were the highs and lows as identified on chart 1.  Now, in this case, I need to read price action to see how Q4 high was reached instead of the Q4 low.
  • The end of December had put in a new structure low at .98200 and this level held throughout January as price moved sideways early on.  If price was going to the Q4’s low of .97364 then it would need to break the structure low if .98200, this did not happen as price broke out of the sideways box, up.
  • The green box labelled Rotation Bullish; when I see a price pattern like this, I view it as possibly market movers switching sides.  In this case switching from sellers to buyers.  They are buying USDCAD.
  • The early part of January gave clues suggesting price may move up towards the Q4 high.  First, the structure low at .98200 held.  Second, a bullish price rotation pattern emerged, and price moved up outside of it.
  • If price does not move towards the next key support level then chances are it will move to the opposite next key resistance level.

All of the above tells me sellers are selling less and less at these price levels.  When sellers are selling less it means price will move higher.  Or, I can say: buyers are buying more and more, and as their demand to buy more grows price will move up.

Either way the behaviour of price is suggesting taking long position should have a higher probability of being right than taking short positions.

  • Taking a long trade once price moved out of identified bullish rotation box, in this case, paid nicely.  Though price stalled a little above the rotation box it did not show any signs of reversing down.
    • Possible signs of reversing down would be price moving back into the box.  Or breaking below and closing below the impulse bar that moved price out of the box.
  • From the slow down above the green breakout box, price then moved up and through SH quickly hitting limit 1 target.
  • The closes above the structure high (SH) formed a bullish flag pattern further suggesting the Q4 high is in play and reachable.  Once price took off up, again, it quickly reached Q4 high hitting limit target 2.  There was nothing in price action suggesting sellers had any fight or interest in slowing down the buyers.
  • Above the Q4 high additional highs were not made suggesting sellers liked this price and started selling preventing price from moving further up,  and or buyers were unloading their longs, and or fewer new long contracts were being added at this level.
  • As price moves down from this level, I need to look for clues to answer is price reversing the long-term trend or is the current up trend just pulling back?
    • From this new high, above the Q4 high, price retraced down to the previous structure high (SH), around .99700 finding support.  Once a bottom was found and price resumed up it can be safe to say a new higher low (hl) has been put in and price is not reversing but just pulling back.
  • Once the steam of the bulls ran out and sellers entered the market a double top was set in early March and priced moved down from there finishing out Q1 2013.  This will be where I pick up for Part 3.

Conclusion

I can use previous significant, in this case the quarterly, highs and lows to identify support and resistance levels to gain insights for future price action.  At these price points, I can draw horizontal lines then wait for when price reaches them again.  If price does not move to one and then aligns to move to the opposite level then, I can look for trades in that direction to that level. Once the level is reached, I should continue to read the price clues, left behind by buyers and sellers, to see where price may go next.

I can further draw in and use structure highs and lows to gain insight to which level price may move to and how to evaluate it once it gets there.  The key is to read and see who is winning the battle, buyers or sellers.  If buyers are winning then price will move to resistance levels.  Once it reaches the level another battle will occur between buyers and sellers.  If at resistance levels buyers are winning the battle then price will break that resistance level and move further up.  Often when a significant high or low is broken price may come back and test it. These are ideal areas to join the longer term trend but entry signals must provide high probability with low risk.

Where to draw Horizontal Lines and why? Part 1

The Art of drawing horizontal lines and how to evaluate their strength. 

Identifying Support and Resistance Levels.

This case study is to assist me in better choosing where to place horizontal lines and how to evaluate their usefulness.  I will select obvious highs and lows from recent price action to draw horizontal lines, for this I will use red lines.  I will determine these horizontal lines from past price action but their usefulness is in the future.  Well chosen price levels to draw horizontal lines can serve as boundaries to where price may move to and or reverse from, in the future.  In between these obvious support and resistance levels will be other valid points to draw horizontal lines,  I call these levels structure high or low, and will use blue lines to highlight them.

This case study will only identify horizontal lines and look to see when they come into play again.  I will focus on the battle between buyers and sellers before price return to a line, again.  Once price returns to an earlier identified level, I must continue to read the battle between buyers and sellers at the lines.  This is a significant battle to understand and to know who is winning, as it will give valuable insights towards whether the line will hold or be broken through.  If sentiments are correctly read based on price action at these levels it can help prevent taking low probability bad trades in the wrong direction.  Reaction at these key significant levels can be excellent guides towards the medium to long-term trend direction and strength.

Clues towards who is winning the battle, at key price levels, identified by horizontal lines, may come from structure levels and or when higher lows (HL) and or lower highs (LH) are set.  When higher lows are being made it suggest buyers are greater than sellers and in control of the overall up trend.  When lower highs are being made it suggest sellers are greater than buyers, at the key levels, and will move price down.

Using my combination of support / resistance levels with structure highs and lows has help me avoid a lot of bad trades with low probability of success.  Understanding it more and combining it with a few other price action tools should help me identify higher probability trade set ups, and then entries with protective stops and realistic limits.

Here is the EURUSD daily chart with key significant highs and lows identified by red horizontal lines and in between structure highs and lows with blue lines.  Below the picture is a definition of how I may use these lines.

  • A support horizontal line is drawn at the lowest low for a chosen time period.  The support level will hold if buyers like this price more than sellers and enter the market taking long positions.  The absence of sellers at this level will move price higher until sellers see a level they like and enter the market.  How do I know, from price action, that buyers are greater than sellers?
    • Knowing that a level has held is not an immediate result.  When price approaches and reach a support level, depending on the time line being used, the first challenge would be to wait for the bar to close, this is where patience and focus is greatly needed.  Once the bar closes, I need to look where it closed.  If price moved and closes below the support level, then this may suggest the level is broken.  This would happen if buyers did not come in and buy at the support level or if they were outnumbered by sellers.  More clues are need to assist in correctly evaluating.  For example, after closing below support, if price moves back up and puts in a new lower high then moving back down to the support level this may suggest the level is broken and price should move further down.
    • If price bounce off the support line and move higher up breaking structure highs and lower-highs then it suggest the level held.  Setting higher lows above the support level is another clue support has held.  Further, indicator tools should become aligned bullish.  If these fail to happen then the support level may become weak and price may break through it when reached again.
  • A resistance horizontal line is drawn at the highest high for a chosen time period.  As price approaches and reaches the resistance level, it will hold when sellers are selling more than buyers are willing to buy, here.  If more people are selling than buying at a resistance level then it should hold and price move down (of course, if this does not happen then buyers are stronger and price moves up, sometimes it is not what happened but what did not happen that can help read price action).
    The further down price moves without significant rallies up shows the strength of sellers over buyers.  If price cannot break and close above the resistance level and then proceed down breaking structure support levels with rallies only producing lower highs, this all suggest sellers are in control and price is likely to move further down.  When this is happening all indicators should read bearish.  If at any time this is no longer true then it may suggest sellers are losing control and buyers may be coming into the market in greater numbers.  This is why patience, focus, and discipline is needed to win at forex; when all three of these are being used it can help to prevent bad wrong trades with low probability.

In Part 2, I will review and discuss the above as it played out in USDCAD Q1, 2013.  I believe this simple tool of drawing horizontal lines and then reading price reaction at them can be used on any trading instrument and on any time frame.  Though, dentifying these levels, especially on higher time frame charts (4-hr to weekly) will aid in analyzing the reliability and limits of price action tools and indicators on lower time frames, 1-hour to 15-minute charts.