on price charts, you will immediately realize that the appearance of multiple Category 2 support areas in a relatively short time span is further evidence of a predominance of buying pressure at a particular price level. Thus, with additional evidence of greater demand at a given price level, the trader will have increased confidence that a significant support level is present. On the other hand, and more important for our trading purposes, should market forces eventually break this support, an additional acceleration to the downside should be expected.

Although this subject will be covered in considerable detail later in this book, there are two formations on Figure 7.4 that are significant with regard to the use of these support points.

Note the first two support points on this chart, labeled Support Point #1 and Support Point #2. Shortly after these points were established by market action the market traded sharply through these levels. If these points are supposed to be supportive, why are they important if the market moved through them so easily?

The answer is that, since we have determined that these are indeed significant support points, the movement of the market through these points is an event worth noting for our trading purposes. The trick is to place a sell stop below these critical support points to give us an automatic entry into the market in the event these levels are violated. This is a very powerful concept when combined with information gleaned from the Directional Day Filter and the correct interpretation of the signals from our commonly used oscillator indicators. Much more on this later.

Resistance

As you might expect, Category 2 resistance is formed in much the same manner as Category 2 support. The only difference is that, when defining resistance above the market, we are considering the highs of the bars in the chart pattern rather than the lows.

To form a Category 2 resistance pattern, first the two bars prior to our resistance level must have two highs that are lower than the high of the bar that is our Category 2 resistance level. Additionally, the two bars following our resistance point also must have highs that are lower than the high of the bar pinpointing Category 2 resistance.

An example of this type of formation can be found in Figure 7.5. Note the formation highlighted by the gray ellipse near the upper left corner of the chart.

Figure 7.5 Category 2 resistance is completed when two bars on either side of the pivotal bar appear with lower highs. Obviously, these plots are not available for use untilthesetwo final bars are finished. Note how, in this case of a falling market, these resistance points can be used for the placement of a trailing stop to protect profits from a short position. Chart created with TradeStation® 2000i by Omega Research, Inc.

Again, as with the Category 1 resistance pattern discussed previously, the high that marks the level of resistance on the formation is found on the center bar of the group, in this case the high of bar 3. The point of interest is also marked by a black dot above the bar. Note that bars 1 and 2, which precede bar 3, both have highs that are lower than the high of bar 3. Also, the highs of bars 4 and 5, which complete the pattern, are lower than the high of bar 3. Although similar patterns appearing later on this chart have slightly different structures, the primary feature of the center bar of the group of five bars plotting the highest high of the group can be observed in all instances shown here. The third resistance area highlighted on the chart shows a more symmetrical pattern than the first two patterns. In this formation you will note that bar 2 has a higher high than bar 1 and bar 4 has a higher high than bar 5, thus contributing to the relatively greater symmetry of this bar sequence. Although the more symmetrical formations may be more easily recognized at first glance, it is important to note that all patterns shown have equal validity as they relate to our primary purpose, which is to define accurate resistance points on any price chart. The significance of the

formation remains the same regardless of the relative positions of the highs of bars 1 and 2 to each other. The same fact holds for bars 4 and 5. The critical property of this formation is that two bars on each side of the pivotal bar must have lower highs.

Category 3 Support and Resistance

Although each and every trader will use these tools to define and/or enhance his or her own trading style, it is this level that I find to be the most useful when defining specific entry points for most trading charts.

The only difference in the structure of Category 3 support and resistance as opposed to the previously discussed Category 2 formations is the necessity for an additional bar on each side of the pivotal bar to complete the formation.

support

The Microsoft chart, Figure 7.6, illustrates the construction of three Category 3 support points. Note that each formation is completed when three bars on each side of the pivotal center bar are printed with higher lows than the center bar.

We will use this chart again when we discuss the specific entries into high-percentage day trades. The chart will give specific indications of a downtrend in place for the remainder of the day after only one hour has elapsed during the marketing day. We will also describe an exhausted correction to the upside between 9:30 and 10:00 a.m. Finally, we will use the support points described by the Category 3 support pattern to give us a specific short entry point at 59.375, which allows us to participate in the down move that follows.

Resistance

To complete our examination of our six support and resistance formations, lets now consider Category 3 resistance.

Figure 7.7 illustrates five such resistance points on a five-minute chart of Sun Microsystems Inc. (SUNW) stock.

Again specifically take note of the fact that there must be three bars on each side of our pivotal center bar for the Category 3 resistance formation to be complete.

In Chapters 10 and 11 we will discover that it is possible to describe

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Figure 7.6 Category 3 support requires three bars on each side ofthelow bar with higher lows. This chart will be used later to demonstrate the use of theS6 critical points for both trade entry and protective stop placement. Chart created with TradeStation® 2000i by Omega Research, Inc.

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8UNWLAST-5 min 10/04 2000 0=111 438 «•? 8 « » 0=106.500 H=t08.734 1x101.825 «=16707500 Category 3 S&RI5)

Figure 7.7 Category 3 resistance points musthavethree bars on each Side of the high bar with lower highs. Notethatthe second and fourth formations, while lower than similar formations that precede them, have equal validity for stop placement as the higher points.

Chart created with TradeStation® 2000i by Omega Research, Inc.

86 MARKET-DEFINED SUPPORT AND RESISTANCE CATEGORIES

accurately an uptrend early in this day and define an exhausted correction within this uptrend. It is then possible to utilize the points defined on the chart to issue specific buy stops first at 104.625 and then at 108.50 for entry into the long side of this market.

MULTIPLE AND SIMULTANEOUS FORMATIONS

As you gain more familiarity with the formations detailed in this chapter you will soon recognize that the various categories of support and resistance often overlap each other. Obviously, all Category 3 formations also contain Category 1 and Category 2 formations by definition. A Category 3 formation with three qualifying bars on each side of the pivotal bar also easily qualifies for Category 1 and 2 formations, which require fewer similar bars for completion. Other combinations of support and resistance formations are not as obvious. To illustrate these complex formations, we will first reexamine a chart used previously in this chapter to detail the construction of Category 1 support.

In Figure 7.8, there are several Category 1 support levels shown, two of which overlap to some degree.

The next chart, Figure 7.9, is a duplicate of the previous chart but with all Category 1 formations removed and Category 3 support formations identified by our familiar black dot below the pivot bar of the formation. The bars making up the Category 3 formation are also drawn with a heavier black line.

Figure 7.9 displays a nearly classical distribution of calculated support points as defined by our Category 3 formation. Note that the support point formed at 10:20 a.m. is slightly higher than the previous point plotted nine minutes earlier. This formation clearly illustrates typical support construction as the market trades higher, showing a healthy respect for the heavy buying that appeared a few minutes earlier slightly above the 177 level.

Equally interesting is the situation created by the next two Category 3 support points. Note that the points are plotted at exactly the same price level, forming what is known as a double bottom. In this case, the market tested previously defined support at 180.375, uncovered considerable buying interest at this price, and traded sharply higher as a result.

As mentioned previously in this chapter, we will be using these

MULTIPLE AND SIMULTANEOUS FORMATIONS 8 7

rW0LAST-1 min 09/27/2000 C=I80.563 -6 500 -3.47% 0=174.125 ¹179.688 L=174.125

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Figure 7.8 Multiple Category 1 formations may be found at significant areas of support or resistance.

Chart created with TradeStation® 2000i by Omega Research, Inc.