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16

8 8 MARKET-DEFINED SUPPORT AND RESISTANCE CATEGORIES

calculated support points to place sell stops for entry into a short position should this defined support fail to hold. This chart will be used again later to demonstrate in detail why stops are not placed at the exact calculated support point, but, in this case, slightly below the exact point. Briefly, our sell stops are lowered slightly to prevent being filled on a short entry at a double bottom such as the one illustrated in the chart. Setting the stop a bit lower assures that the market must violate calculated support in order for us to get a fill, not just equal the support level and then trade higher, immediately putting us in a loss position. Much more on this theory of stop placement later in the book.

Now lets again show the same chart with a larger black dot identifying the pivot point of the Category 3 support along with the previously selected Category 1 support points.

Study Figure 7.10 carefully, observing the interactions of our two support patterns as they identify various levels of market support. The points identified by the Category 3 support, as noted in previous comments, are in this instance more effective for market entry than the Category 1 support also shown here. Although the Category 1 patterns

k$ Ti.ideSt.jlmn Chrfit - (I TWO) \2 Technologies Inc limjpfl

ITWO LAST-1 min 0 7 C=180.563 «.500 *u.>e% 0=180.063 H=187.250 L=166.126."

10:01 1C:C6 10:11 10.16 .21 .26 31 .36 <1

Figure 7.10 Individual Category 1 support formations are often discovered within the enveloping Category 3 structures. In this case the resulting Category 3 formations have greater significance. Chart created with TradeStation® 2000i by Omega Research, Inc.

MULTIPLE AND SIMULTANEOUS FORMATIONS

will appear more quickly on the chart due to the limited number of bars required to complete the formation, the Category 3 points, while taking longer to surface, are in this instance definitely worth waiting for.

As you apply these chart patterns in your study of a particular market you will soon notice which patterns and indicators are the most effective in their predictive ability for the issue or contract that is the subject of your interest. Obviously, in this instance, Category 3 support is more effective on a one-minute chart of ITWO than Category 1 support. If you were to examine a series of one-minute charts of this issue, carefully studying the application of these two support patterns, you would soon form an opinion of which pattern appears to be the most effective on this market. If one were to apply these same tools to a five-minute chart of Microsoft, it is probable that a different conclusion would be drawn. It is for this reason that three levels of support and resistance are examined in this chapter. Different categories of this important tool will be useful on different markets and different time frames.

Often, when referring to indicators such as our support and resistance formations described here, we will discuss these tools as having different sensitivities. Sensitivity, in this context, simply refers to the amount of market activity required for the pattern in question to express itself. Formations requiring a relatively minor amount of market activity to complete their structure are deemed to have a higher degree of sensitivity since they can be significantly affected by minor market moves. Therefore, a Category 1 formation is more sensitive than a Category 3 formation since significantly less market activity is required to complete its final structure. Indicators with a higher degree of sensitivity will appear more often on price charts.

For example, as defined graphically in Figure 7.11, Category 1 support and resistance, with a higher sensitivity, will be plotted on a chart more often than Category 3, which carries a lower sensitivity.

Users will usually find, when using shorter time frame charts, that the higher-sensitivity indicators will appear too often to be of significant trading value. These charts can show a tremendous amount of bar-to-bar activity The lower-sensitivity tools are more reliable in this instance. While trading this time frame can be useful for taking small, consistent profits out of the market, it is often preferable to use a lower-sensitivity indicator on such a chart to give the trader a bit of a broader look at the current trend of the market than is provided by the rapid appearance of successive price bars.



ri,i«JeSl.itipn C.hdit [AMiN J Lorn Inc (AST -1» nun f£v

AMZN LAST-5 min 1 03/2 0 ; 0=35 1 25 *I31 7 *J0.11% 0=13.876 H=25.375 L=18.375 V=H5O550O Category 1 S&R(4)

.......i -*............................----- ...... : - - -*..............-:........ ........-.

...... .......j.. : jtffiir- , .-, .., (.. ; ...........

,fj I ";Jl1..... ;;-;:; 1 lbn

Category 1 11

-37.400 -36.800 -36.200 -35.600

Category 2 S&RC4) AMZN LAST-5 min 10/03/2000 035.I.M .1313? -6011* 0=19.876-H=25.375 L=19.375

! Category 2 tjj

-37.400 -36.800 -36.200 35.600

Category 3 8&R( 4) AMZN LAST-5 mm 10/03/2000 C=35.125 -13.187 »60.1 <4 0=1S.875 :H=25.375 L=1 9.375

.......kiki......; ,i)mi<i*..........i.....1 " ,, -...............

j Category 3

-37.400 3S.800 36.200

-35.600

10/03 9:00 9:25 9:50 10:16 10:40 11:06 11:30 11:55 12:20 1245 1 10 1 35 200 226

Figure 7.11 Category 1, 2, and formations identified on identical five-minute chartsillustratethe relative plotting frequencies of the various sensitivities of support and resistance. Chart created with TradeStation® 2000i by Omega Research, Inc.

On the other hand, those using longer time frames such as 15- to 30-minute charts will find that the lower-sensitivity indicators may not appear on their charts at all, and if they do, may be too far behind current market activity to be useful. The higher-sensitivity trading tools, which require fewer bars to complete their signals, are a more practical alternative in this instance.

Sensitivities for Entry versus Exit

Traders usually find that the same sensitivity that proves useful for the placement of buy and sell stops for entry may not, in the final analysis, prove to be the setting that is most productive when used to first place and then move trailing stops.

It may be the choice of traders to use the lower-sensitivity Category 3 formations to place stops for entry, as the market acceleration that usually accompanies violation of support and resistance is often more pronounced with this chart pattern. However, this same formation, since it takes considerable market activity to complete, may not be as productive when used to place trailing stops. Higher-sensitivity Cate-

gory 2 or even Category 1 support or resistance may be a more useful tool for this purpose, especially when the trade progresses to the point when there are significant profits to protect. As always, the choice of sensitivity settings with respect to support and resistance determination is highly dependent on the trading style of each individual.

For comparison purposes, Figure 7.11 is presented to further illustrate the appearance of our three sensitivities of support and resistance patterns. Each segment of the graph plots an identical five-minute chart of Amazon.com. As labeled on the graphs, Category 1 support and resistance are plotted on the top segment, Category 2 on the center, and Category 3 on the lower portion of the chart.

By now you are probably asking, "With all the choices of indicator sensitivities and charting time frames, which combination am I to use?" The answer lies within the structure of your own preference and trading style. As discussed earlier, highly successful traders develop a trading style which fits their personality, risk tolerance, and trading goals. They develop this style to a high level and implement it precisely. As you experiment with various indicator combinations and time frames you will discover for yourself which combinations will be the most useful considering your own trading personality profile.

RECOGNIZING THE PATTERN

This chapter thus far has concentrated specifically on the construction and interpretation of the six support and resistance categories we will be using to define entry and exit points for trade placement and exit placement later in this book. Additional considerations are important concerning the accurate recognition of these points on a real-time basis.

First of all, recall that in each case discussed a certain number of bars must appear after the bar that defines the actual point we will use in trading. As a result, these specific points are not available for use until after these trailing bars have been completely formed. It may seem like a simple point during a discussion using historical charts, but it is of vital importance to understand this concept completely before using the technique in real-time trading. On the historical charts used for the explanation of the use of these points it looks as though the areas in which we have an interest clearly appear well before the time when they must be used to place buy and sell stops.



However, in real-time trading this is not the case. In fact, one may have a very short time in which to discover the important price level and place the appropriate order. Several following charts illustrate this point.

For our real-time example we will use a one-minute chart of Amazon.com, Figure 7.12, from the early-morning trade on October 4, 2000. The only notable feature on this chart so far is apparently aimless, sideways activity in the $33 area. We will advance this chart a few bars at a time to demonstrate the activity of our resistance indicator.

Adding three more bars to our chart, we now see a pattern developing in Figure 7.13 that at first glance appears to be a continuation of the same trendless activity we have observed so far in the days session. Note that, to the casual observer, the market seems to be forming a triple top in the $33.00 to $33.25 area on the chart.

Allowing three additional bars to appear on our chart in Figure 7.14, our earlier suspicion of a triple top appears on the verge of coming to reality.

Closely observe what happens with the print of a single additional bar on our Amazon.com chart in Figure 7.15. The latest bar to appear on our chart is the third bar in the sequence that has a high that is

TirtdeSlalion Chait - (AMZN) Amazon.Co]

WZN LAST-1 min 1O/04/200D C=3S.O-3e: +4.437 :+14.C

-8:46 8:51-fl-fifi 4m °" t-"

Figure 7.12 Initially this chart appears to be one of a sideways, trendless market.

Chart created with TradeStation® 2000iby Omega Research, Inc.

MZNLAST1 n*l 10 34 C--3E.DG0 4 437 44

34.500

l,y.l:

- mi a sb q-ni - 6 911 3:16 9:31

Figure 7.13 Adding three bars to Figure 7.12 givestheinitialappearance of a developing triple top.

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

AMZN LABT-t min 1 /2000 0=36.000 i.iJ-. *M 06?

346 0:51 e:56 9:01 9:06 9:11 9:16 9:21

34.000

33.500

- .

Figure 7.14 Adding three more bars appears to confirm the topping formation.

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



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