The author starts off the TA section with a general “warning” that:
“technical analysis provides a snapshot of market moves that have already occurred. The resulting snapshot is a picture that is always lagging and limited in resolution.”
Which is rather strange as he later describes S/R as:
“What is most significant about horizontal support and resistance lines is that they are not lagging. In contrast to indicators, they are projections”
But maybe the key question is whether lagging actually matters or not! Is it a benefit or a hindrance to projecting where price might go next? Certainly, S&R levels are greatly concerned with where price has been before and has paused. Similarly MAs are a moving window designed to highlight where the current window of ave prices are in relation to earlier windows.
I like the author’s description of TA, and in particular PA, as “mapping” the price and thereby determining its “location”.
He says about S/R levels:
“The basic technical measurement of horizontal support and resistance provides the ground floor of technical analysis. Whenever you look at a currency pair, you have to ask where support is and where resistance is. The answers provide the first mapping of the market.”
I am sure that S & R levels are a major exhibit on most trader’s charts but I have to confess that I have some difficulties understanding just why S/R levels form in forex markets. Much of the technical analysis approach was developed for trading equity and commodity markets and I can see logical reasons why there might be S/R levels in these markets but forex is a bit different.
For example, share values reflect the actual/potential worth of a company. As such, it is possible to envisage where share prices can be considered “cheap” or “expensive” with respect to that company. Similarly, commodities like coffee, copper, wheat, oil, etc have a market affected by supply and demand. Supplies cannot be rapidly increased and demand is a factor of price. Therefore, again, areas of price can be observed as reflecting this factors.
But what underlying factors might cause a currency pair to pause and reverse at the same levels. Here, there are two currencies and each is the price of the other. There are outside factors impacting both currencies separately and which vary all the time. Certainly, investment funds and import/export companies will identify levels that “work” for them but a) do these levels always remain the same, and b) are these particular interests sufficiently large to dominate the forex market as a whole tothe extent that they form turning points?
Personally, I suspect the forex S/R is more a technically-based phenomenon driven by a) many speculative traders identifying and observing the same levels, and b) a sufficiently large volume of speculative interests to be able to drive the price, albeit sometimes only temporarily.
The reasons for S/R are, however, maybe not so important as realising how to use them!
The author states:
“When price establishes support or resistance, the market recognizes that location as a zone or hurdle that has to be overcome. The immediate future price movements need to probe and penetrate a support or resistance line. One of the first principles of trading forex is to locate a trade near support or resistance”
One major issue here is recognising that S/R lines are not precise lines but zones. It is the broad use of charting that tends to focus attention on these points and condense them to very precise levels. But price can often fall short or protrude through these levels and that should always be taken into account when considering entering or exiting at these levels. Decisions need to be made whether to enter above or below the level, and whether when the level is reached or when it rebounds/breaks through.
The author also draws attention to the importance of forming an opinion concerning the strength of the S/R lines. Here he highlights two factors. The first concerns how many times the level has previously turned prices, i.e. the more times it is hit the more relevant it is! The second concerns the time frame on which it is recorded , i.e. S/R levels noted on longer time frames such as monthly and weekly can be considered more significant than, say, hourly charts. It is certainly hard to figure out an underlying cause for hourly chart S/R other than purely technical - and therefore these are surely more susceptible to failure than with the longer term charts.
The author then moves on to trends and trend lines, but this post is already far too long. So time for a break.
Coming: Trendlines and multiple timeframes
Not coming: The author also talks in this chapter about using three-line break or renko charts to reveal trend changes. I don’t use either of these so I am not going to comment on them.