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Tips on Technicals: Support Becomes Resistance

Tips on Technicals:
Support Becomes Resistance
By Michael N. Kahn

Support and Resistance

Simply stated, support and resistance are respective price levels at which
prices stop going down or up. A price in any market is one at which buyers
and sellers have agreed upon fair value. If more buyers think that price is
fair, they will attempt to buy. This, in turn, raises demand and prices rise.
As prices rise, buyers become less active and sellers become more active.
At some point, buyer and seller activity will balance and this price level
becomes resistance. The more times a market touches a resistance (or
support) level, the more significant it will become. This is because buyers
and sellers simply don’t perceive fair value to be any higher than that level.
The market will have difficulty in rising further unless something happens
that causes perceived fair value to rise. Let’s use an example in the stock
market. Resistance for the stock of XYZ company is at 50. The market
bounces around below 50 for several weeks until the company announces
better than expected earnings. Now, both buyers and sellers think that
fair value is higher than 50. The market breaks out of its trading range
and trades higher until buyers and sellers agrees that fair value is 55. An
interesting thing now happens. If the market trades back down to 50, buyers
who missed the earlier breakout will see their second chance to go long.
The market bounces up off the 50 level which has now become support. If
the market makes it back to the 55 level, sellers who missed their chance
to unload their stock at the high earlier will become active. This increased
supply resists the market’s attempt to move higher so prices once again fall
back.

The chart of MATIF June Bonds (figure 1) illustrates this point. The two
highlighted areas show how the market traded lower off of a resistance level.
Later, it failed to break through on its second attempts as sellers who missed
the first opportunity took advantage of the second.

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Tips on Technicals: Support Becomes Resistance

Figure 1

Figure 2

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Tips on Technicals: Support Becomes Resistance

Support and resistance levels can be found in all time frames, from tick
to daily to monthly and longer. The 120, and 126 and 135 levels in spot Yen
have been significant levels for the past five years (figure 2). When analyzing
the major trends in a market, going back far enough in time will reveal
prices in the past that have been significant market turning points. Analysts
predicted that the price of Crude Oil before the 1991 Gulf War would reach
$38 US based on cash prices going back to before there were Crude Oil
futures.

The German DAX Index rallied several times after its July 1992 sharp
decline and each time it was stopped at a level that provided support back in
1991 (figure 3).

Figure 3

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Tips on Technicals: Support Becomes Resistance

Figure 4

Measuring the Move

Trading ranges are simply areas of price action between support and
resistance levels. In our example above, XYZ traded in a 50 - 55 range.
In the June 1993 Comex Gold Chart (figure 4), prices in November and
December 1992 were locked in a range from about 335 to 343. The market
started 1993 by gapping down and establishing a new trading range. Former
support at 335 became resistance and new support was established at 327.
At the end of March, the market gapped up through resistance and rose until
the old resistance level at 343 stopped it.

When the market fell through support in January, the question to ask was
“Where should I look to buy this market back again?” The answer could be
found by measuring the height of the previous trading range. Markets tend
to move integral multiples of the previous trading range and in this case that
was $8. The lower range was, in fact, $8 wide. Had prices fallen through
327, the market could be sold with an eye on the 319 level.

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Tips on Technicals: Support Becomes Resistance

Note that prices in the real world can violate our rule in that the market
briefly traded through resistance in February. Technical analysis is subject to
the analyst’s interpretations.

In a future edition of “Tips” we’ll cover trading channels. Channels, like

ranges, can also measure price breakouts. The channel in figure 4 was
about $13 wide so when the breakout occurred in March, prices rose $13
to $343. Since this is the same as a previous resistance level, it becomes a
very significant price for the future. The more technical indicators that agree,
the stronger the signal.

About the Author

Michael N. Kahn is a columnist for Barron’s Online based out of Florida.

He also writes a free technical newsletter. To subscribe to this service,
please visit www.midnighttrader.com. The complete collection of Michael
Kahn’s “Tips on Technicals” is available in Real World Technical Analysis at
http://www.crbtrader.com/pubs/rwta.asp.

About Tips on Technicals

Each edition will cover one aspect of analysis; some being simple and
some being a bit more advanced. The accompanying charts were taken from
relevant CRB products.

Copyright © 2009 Commodity Research Bureau www.crbtrader.com Page 5

Tips on Technicals: Support Becomes Resistance

Other Commodity Research Bureau Publications:

»50 Rules of Futures Trading

»Charting Tools for Professional Traders

»Guide to Technical Indicators - Volume 1

»Guide to Technical Indicators - Volume 2

»Guide to Trading

»How to Spot Profitable Timing Signals

»How to Use Charts to Forecast Futures Prices

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