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Support and resistance levels are important to the short-term trader. if prices start to move higher, slow down, and finally reverse, it is natural to consider the top price as a resistance point. Prices are thought to have been stretched to their extreme at that level. Any subsequent attempt to approach the previous high price will be met with professional selling in anticipation of prices stopping again at the same point. In addition, it is common for the same traders and others to place orders above the previous high prices to take new long positions or close out shorts in the event of a breakout.
This method, very popular among floor traders and active speculators, tends to create and emphasize the support and resistance price levels until they define a clear trading range. Within a Ito 3-day period, these ranges can be narrow and yet effectively contain price movement. During the life of the trading range, it will continue to narrow as the levels become clear to more traders and the anticipation of a reversal at those levels becomes imminent.
To take advantage of the smaller ranges caused in this manner, it is necessary to enter positions during the middle of a trading session, frequently holding that trade until the middle of the next session. An example using the Chicago Board of Trade December 75 Silver contract, during August 1975, will help to illustrate this. The opening and closing prices for the first 3 days do not indicate any opportunity for trading. Prices were generally in the middle of the daily range. By using the high and low of the previous day, this situation can be traded either of two ways.
Thursday, August 2 1, forms a range of 505 to 493, closing near the center of the range. After the next open, buy just above 493 and sell just below 505 to be certain of entering and exiting the position. For protection, a stop can be entered at about 506 and 492 to reverse the position on a breakout. Had this procedure been followed, entering 29 (200 points) before the bounds of the range.
In each case, the entry was 200 points before the level at which prices had reversed on the prior day. The Stop-Loss order was placed to limit losses to a 100-point penetration. Although this is an ideal situation, professional traders frequently use this method. It can be seen that the support levels did actually rise from 493.00 to 494.50, and then to 496.00. When support was penetrated, prices rapidly broke to new lows of 483.80, down to the permissible limit. Similarly, the resistance level remained intact going from 505.00 to 504.00, 504.50, and finally, 504.00. It is generally accepted that the resistance level represents a more volatile area that must be watched closely for false breakouts.
Support and resistance levels gain importance the more time they remain intact. The high and low of the prior day are not as significant as the weekly or the monthly range. Each can be traded using the same technique. The major support and resistance levels are contract highs and lows, which rarely allow breakouts with less than one attempt. Longerterm price objectives can be identified using a continuation chart. This chart plots only the nearest (spot) futures contract of a specific market to allow the location of support and resistance levels when the current contracts are in a new high or low area.
Before 1990 there were very few published day trading systems. The more recent ones have had the benefit of sophisticated computer programs and large historical databases. The following method precedes this era and remains unique and a valuable part of our literature.