Simply Support and Resistance

Posted March 13th, 2012 by Sam Evans in Education

Simply Support and Resistance

First, let's recap the most important feature of Supply and Demand - namely, the principle behind it. It goes something like this:

"Price turns in any market will occur only when the Supply/Demand equation is out-of-balance. When there are more willing sellers than willing buyers, this equates to a greater level of supply than demand, thus prices have to fall. When there are more willing buyers than sellers, this equates to a higher level demand than supply, thus prices have to rise. When this simple and straight-forward equation is most out-of-balance, we will see the most powerful shifts in price. The origins of these imbalances, in turn lead to the most objective, low risk and high potential reward trading opportunities that the market has to offer."

If a disciplined trader who is prepared to follow a well-constructed and rule-based plan understands this concept, then there really is no reason why said trader should not succeed in the financial markets, given the right level of education and ongoing support. If there is one vital lesson I have learned in my own trading career that has served me better than any others, it is to keep things as simple as possible in trading as this is really nothing more than a game of probabilities and mental fortitude. By applying the logic of the supply/demand dynamic to our trading activities, then we will always maintain a reliable edge in the marketplace.

So, what factors go towards finding the very best supply and demand opportunities in the markets? Well, out of respect for the ever-growing Online Trading Academy Alumni, it is impossible for me to disclose every one of the Academy's "Odds Enhancers," yet I can happily share a few tips and advantages in finding some of the best levels around. Let's take a look at two of the best. These are Imbalances and Rewards.

Imbalances

The structure of a price imbalance is perhaps one of the most defining features in the structure of a quality price level. Remember what I stated above? The largest imbalances lead to the best trade opportunities. With this in mind, we can look to the example below which shows a selection of quality levels:

Figure 1

In this example, taken from some recent trading activity on the CADJPY, we can see a selection of supply and demand zones. While there may be a number of other trading opportunities from regular areas of support and resistance, we should note that the levels highlighted are origins of powerful supply and demand imbalances, clearly reflected in the moves in price from their origins. Only a strong imbalance could ever cause such a strong move to happen at all. Only a huge disparity between the number of willing buyers and sellers could move price in such a potent fashion, therefore, the origin of these moves provides the objective and planning trader with a variety of unique trading ideas. Observe also how we are not concerned with jumping into too many trades, but rather we are only interested in a select few, namely those with the greatest imbalances in price action.

Rewards

Reward is the reason we all begin trading in the first place. It's okay to be honest with yourself. I doubt any trader has ever taken it up just for the fun of it! Now, while we are happy to look for those rewards in the market, we often let the excitement of making money overpower the reality of losing money. Everything we do in trading is about risk-versus-reward, no exceptions. Often, risk is defined as just the financial risk involved in the trade itself, controlled by the all-important stop loss. However, risk is also defined by the type of trades we take and also how often we choose to trade. Think about this. The more trades you take on a day-to-day basis, then the more financial risk you are potentially allowing as well. The less trades you take with tight sensible stops and greater potential rewards leads to an overall lower risk profile as you are not exposed to the market as often. Take the example below:

Figure 2

In Figure 2, we can see a number of regular support and resistance lines marked off. Some of these levels have been just support or resistance, while others have been both at some moment in time. The danger we face if we mark off too many potential trades is that we can easily overtrade and end up chasing the market for a result before we even realize it! With so many trades on offer, which one do you take? A consistent trader wants clarity and simplicity in their plan, not confusion and doubt.

As stated in the above example, multiple opportunities lead to limited rewards and greater risk. By empowering yourself with an understanding of quality supply and demand levels and choosing your levels wisely, and when the odds are stacked in your favor, you will inevitably have less trades on offer, but each trade will offer far greater rewards and you will ultimately face a far smaller risk exposure as you will be trading less often. Just because you are a trader, it does not mean that you have to trade all the time. Being a profitable trader is also the result of not taking trades as well. I hope this was useful.

All the best, Sam Evans