Three main ways how stock price interacts with support and resistance
In the previous lesson 1 we reviewed a real-life case when price kept moving in range bound mode bouncing from cyclical support to cyclical resistance and back. In this lesson 2 we will review several case studies to find out whether it makes sense to fade test of support and resistance levels.
In the previous lesson we reviewed a case study where price more or less respected cyclical support and resistance keep bouncing between them like in a pinball game.
You can watch a video explaining that lesson.
On the chart above we can see that price turned up strongly off cyclical support levels but spent more time testing resistance levels. In some cases price managed to significantly overshoot the level of resistance. That tells us that we cannot expect those support and resistance level to reject attacks of bulls and bears all the time. We need to dig deeper and try to figure out why sometimes price jumps off support but completely ignores resistance.
The obvious reason for that in that case is that bulls were in control pushing price to higher highs with every new swing up. In contrast, every corrective move down driven by bears made only higher lows. That is a great confirmation of the old traders’ adage “trend is your friend”. The practical implication of that observation is that buying a pullback making a higher low in an up trending stock can be considered an attractive long setup.
Based on that observation we can teach our algo to check if a stock keeps making higher highs and higher lows and consider pullbacks making higher lows as attractive long setups producing “BUY PB” signals:
The same principle can be used to identify corrective pullbacks in down trending stocks as attractive short setups. The indicator will produce “SHORT PB” signals:
To make the algo catch that type of a setup just activate that feature in the settings:
That setup makes a lot of sense but that is not the most reliable type of setup that we can identify with the help of that indicator. Quite often that setup fails:
In case of AAPL chart shown above we got “SHORT PB” setups and only one time out of five price overshot the resistance and would make us cover short with a small loss.
That setup works equally well for up trending stocks:
When a stock is trending up bulls do not let price to spend much time at support. Every time a new cycle support gets printed, buyers step in and start buying pushing price to new higher high:
The algo does a great job of identifying that setup on any timeframe. This is for example 60 min chart of GDX (gold miners ETF):
This is how algo caught several buyable and shortable pullbacks on 240 min timeframe in QQQ:
I think I showed you enough examples to convince you that setup would be a great addition to your toolbox.
In the next lesson we will review what happens when price breaks out over the resistance, and I will share with you my favorite trading setup!
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