A question regarding Support and Resistance levels

Hi folks just a question regarding support and resistance.

Why do old levels of support nearly always become new levels of resistance and vice versa?

What is the reasoning behind this?

Support and resistance levels (in all their forms) are basically psychological price levels.

Depending on your personal point of view, you might consider these psychological levels to be [B]entirely rational[/B], or you might consider them to be [B]pure superstition[/B].

But, the fact remains that they have an effect, because enough traders THINK they just might possibly have an effect.
And this works in both directions.

Hypothetical example:

Price struggled to break below 1.5635 — for whatever reason — on one or more previous occassions. What was so special about that particular price? Who knows. Accept it for what it is.

Price finally broke that support, and now, after some time, price is rising toward that 1.5635 price level.

How might various market participants view that level?

If a trader is LONG as price rises toward that previous support level, he might consider liquidating some or all of his position, because he doesn’t know how the market is going to react at that previously troublesome level.

If a trader is flat, but looking to get LONG, he might consider holding off buying, until he sees how the market is going to react at that 1.5635 level.

If a trader is flat, but looking to go SHORT, he might look at that 1.5635 price level as a good place to go SHORT, if price (currently rising) stalls at that level.

All three of the market participants above had two things in common: (1) they became cautious as price approached the 1.5635 level, because they perceived that level to be a place where price MIGHT stall, or reverse; and (2) the actions they took (out of caution) all had the effect of adding selling pressure to the market.

In other words, they unwittingly contributed to the very phenomenon that you are asking about.

We all know that new SHORTS coming into the market put downward pressure on price. Sometimes we forget that when prospective LONGS stay out of the market, they have exactly the same effect: the balance between BUYING PRESSURE and SELLING PRESSURE gets shifted in the direction of SELLING PRESSURE.

One market participant who wasn’t included in the hypothetical example, above, was the trader who is SHORT as the price is rising toward a previous support level. I’ll leave it to you to figure out how he would probably react, and what effect he might have on the market.

Wow Clint thats a great explanation.

Thanks for taking the time to answer me in this much detail.

To go along with what Clint said, don’t forget we are trading “pairs”.

A look at the dollar index can give you clues as to possible turning points when trading the majors.

Then there are the market makers… who know pretty much where price is going. I cite EU Friday as an example… strong resistance well and truely taken out with LOTS of stops in place… kerching! :smiley:

You get a similar debate with many aspects of trading, for example Fib levels. Some people claim that they work simply because so many traders use them that they become a self-fulfilling prophecy. Other people claim that the numbers and levels themselves hold significance, and therefore the market respects them. Whichever side of the debate you are on, few will argue that they do not work.

But basically, I just agree with Clint, a very good explanation.

Simple, if a certain point in the past is significantly visible to many traders, the zone around that point will be an area of entries and exits in the future. A cascade of trades will occur at these levels, producing either a breakout or bounce off the S/R.