Levels in Forex

Support and resistance are the known cornerstones in Forex technical, wherein:

1. a current Forex rate (CFR) is surrounded by levels of:

a). resistance being superior to CFR;

b). support being inferior to CFR.

2. a level breakthrough triggers a leap to a consecutive support/resistance;

3. a false breakthrough is responsible for a rate backstroke (say, from resistance to support).

Thus, having data on resistance and support levels and being armed with R/S true/false criteria, a trader grows faultless-entry skilled to ensure smooth level-to-level trading.

To be found below is a graphic drawing of a flat followed by an R/S up/down breakthrough.

The chart 1. (For view picture see notes in end of article)

In actual sample GBPUSD trade dated January, 31, 2006 the support breakthrough has triggered a bullish in-session trend.

Simple, isn't it? Affirmative at a glance, but 95% of traders losing their forex deposits are calling for natural questions:

1. What's the reason, the world traders are getting entangled in so a seemingly simple regularity?

2. What's the way of correct detection of R/S levels for currencies to use to jet off from?

3. What attributes are inherent to true/false breach differentiation?

It is, thus, to be concluded that a trader will never achieve steady FX gains unless the answer is found to the above three simple questions.

CLASSICAL BOOKS ON RESISTANCE AND SUPPORT LEVELS

Forex scholars' books, when analyzed, are giving grounds why 95% of traders turn deposit-killers. The point is that under different technical scholars:

a). fairly different understanding is being attached to support and resistance;

b). no distinct criteria (except Demark's technique) is in service to finding a support and a resistance;

c). there is no clear-cut interfacing between R/S levels on different timeframes.

Below is sort of understanding classification:

1. A. Elder. R/S are understood by SOME SCHOLARS to be horizontal lines drawn along price highs and lows

support and resistance are horizontal (or almost horizontal) lines linking several minimums (maximums).

The chart 2. Support and resistance (For view picture see notes in end of article)

b). J. MURPHY also indicates that "points 2 and 4 represent uptrend support levels. The figure depicts uprising support and resistance under an uptrend with points 2 and 4 being support levels which use to be coincident with earlier lows. Points 1 and 3 indicate resistance levels, which use to be coincident with earlier highs" (see: "Technical analysis of the Futures Markets"

Fig. 3a and 3b. Uptrend and downtrend support-resistance levels (For view picture see notes in end of article)

2. SOME SCHOLARS believe support-resistance to be sloped lines drawn along price highs and lows (trend lines, actually) as below:

Fig. 4. Trend line-fashion support-resistance pattern (For view picture see notes in end of article)

a). T. DEMARK

Fig. 5. Bid pivot points (TD-points) building up a resistance level (For view picture see notes in end of article)

The TD-points are peculiar of price values being not exceeded within 2 adjacent days. The points are specially emphasized on the chart.

Note that the price movement above the TD-line is mirrored by same after the down break of this line.

Price projection Z is made by way of the following calculation:

- difference is taken between Y being maximum price above the TD-line and X being special price immediately below the TD-line;

- the obtained value is subtracted from A-B line breakthrough price.

b). L. BORCELINO is also a user of inclined lines as support/resistance (view:

Fig. 6. Quoting L. Borcelino: "As evident form these examples, trendlines, drawn across preceding highs and lows, constitute perspective support and resistance projection". (For view picture see notes in end of article)

3. E. NAYMAN'S combined commitment of inclined and horizontal R/S levels (view: "Trader's Minor EncyclopediaJ

"A resistance line connects market important maximums (highs, peaks)", And further on: "R/S lines drawing should be preferably done through price concentration areas, rather than through highs/lows extremes" (???).

Per minimum price trend line (a support):

Fig. 7 (For view picture see notes in end of article)

Example of E. Nayman using resistance/support levels at trade station:

Fig. 8 (For view picture see notes in end of article)

4. MOVING AVERAGES based resistance/support levels.

a). E. NAYMAN: "Bollinger Bands are sort of peculiar support/resistance lines

Fig. 9 (For view picture see notes in end of article)

5. ROUND NUMBERS being support/resistance levels

a). E. LEFEVRE (view: "Memories of an Exchange Profiteer" underlined: "Rates, having, for the first time, traveled 100, 200 or 300 points, are almost sure to cover additional 30 to 50 pips"

b). D. SCHWAGGER: "One is to be especially cautious about dollar holdups. With USD 781,25 best working on T-bonds and USD425 - on soybeans, temptation is raising to find "optimum" holdup for each market. It is advantageous to establish a round number to comfortably use it all of the markets.

CLASSIFICATION OF WEAK AND STRONG R/S LEVELS AS VIEWED BY FOREX SCHOLARS

J. MURPHY classifies support and resistance (view "Technical Analysis of Futures Markets", New York Institute of Finance è Prentice Hall, 1986) proceeding from: price in-domain residence period (1); volume of trade (2) and price domain age (3).

1. The longer the price reciprocation period within a certain support/resistance area, the more critical the area. By way of an example, if a certain stagnation area observed a 3-week price up/down movement with subsequent rally thereof, this support domain is more important than that having observed a 3-day price reciprocation.

2. Volume of trade is another means to evaluate importance of support/resistance. If, say, a support formation did involve a huge volume of trade, it means a huge number of contracts passing from hands to hands, hence the support levels is ranking high and visa versa: the less the volume of trade, the lower-ranking the support.

3. Still another support/resistance importance indicator is its age in relation to the present moment. Since we are dealing with traders' reaction to market moves and to positions they have entered or have failed to enter, it is fairly clear, that the younger the event and the reaction thereto, the more important the event.

Seven years later (in 1993), A. ELDER has confirmed 2 of 3 J. Murphy's postulates dated back to 1986. His classification of resistance/support levels is guided by:

- number of test tangencies it sustained (the greater the number - the stronger the level). Within a fortnight an immediate support/resistance is formed; within 2 months the level grows accustomed to by traders, thus attaining medium power; within 2 years actually a stereotype is built radiating strong support and resistance.

- price scatter dominating a support/resistance level (the wider the range thereof - the stronger the level). A wide-range turning-point price consolidation is similar to a high fence surrounding valuable property. A congestion zone equal to 1 % of current price (4 points with S&P500 at 400 level) yields insignificant support/resistance, whereas a 3% area is responsible for medium levels with a 7% area possessing sufficient power to be a strong trend killer.

- The greater the volume of trade in a support/resistance area, the stronger the levels. Huge volume within a congestion zone is indicative of numerous emotional jobbers' involvement. As opposite, minor volumes point out traders' indifference towards the level being intersected, hence being attribute of the level's deteriorated health.

Weak support/resistance levels are capable of bringing a trend to a halt, while strong ones may appear trend reversers. Traders buy support and sell resistance, thus turning their impact into a self-justifying projection.

SCHOLARS' VIEW ON SUPPORT/RESISTANCE SEATING POINTS

1. T. DEMARK recommends:

- plotting resistance upon bid TD-points

- plotting support upon ask TD-points.

2. D. SCHWAGER (view: "Technical Analysis. Complete Course") insists on drawing resistance and support "in the vicinity" of prior lows and highs.

"Support and resistance are to be viewed as approximate areas rather, than exact levels. It is to be emphasized that any previous high is not at all a premonition of perspective prices dry up thereat or there under. Instead, it is indicative of a resistance to be expected near that level. By analogy, a previous low is not at all illustrative of further price declines halting thereat or there above. Instead, it is indicative of a support to be projected close to that level.

Depicted below is a support zone governed by relative prior highs and lows concentration: gold, futures.

Fig. 10. (For view picture see notes in end of article)

Continued by D. Schwager: "Some technical analysts use to treat previous highs and lows as being endowed with, sort of, holy significance. A previous high, being 1078, is deemed by them a strong resistance. In case the market displays a spike higher, say, as far as 1085, they reason the resistance to have been breached. It's not correct. Support and resistance are but to be looked upon as cloud-shaped areas rather than exact levels."

3. J. MURPHY resorts to plotting support and resistance in a local peak-wise fashion (i.e. by local highs and lows): "A resistance level usually coincides with the previous peak level".

Fig. 11. (For view picture see notes in end of article)

Fig. 12. (For view picture see notes in end of article)

4. A. ELDER: "Resistance and support are to be preferably plotted (see Fig. 13) through congestion zone margins (CZM) rather than through highs and lows. CZMs constitute traders' mind-changing areas, whereas highs and lows are only reflective of panic among weakest jobbers".

Fig.13. (For view picture see notes in end of article)

Continued by A. Elder: "Beware of support/resistance false breaching, indicated as "F" in the above figure. Breaches are followed by amateurs, with professionals being opposite travel jobbers. Now, pay some attention to the chart's right corner, where prices have bumped into strong resistance. It's high time to hunt for shorting with a stop-loss to be placed slightly above the resistance level".

To be noted is a pronounced regularity, not referred to by A. Elder: the support/resistance levels drawn through previous local peaks are not extended by him after false breaching thereof.

4. D. SCHWAGER gives the following explanation when resorting to projection of 2 (!) inclined support and resistance levels:

- "Standard lines are usually drawn through price extrema (highs, lows), attributable to traders' emotions, therefore these points may not reflect the market's real trend".

- "An inner trendline is to be plotted closest to the bulk of relative lows and relative highs, ignoring extreme points"

D. Schwager himself is the recognizer of the subjective nature inner trendline method, but in so doing he jumps to a very important conclusion that ordinary trend lines are:

- similarly subjective (!);

- far less helpful (!), than inner trendlines.

"One of inner trendlines' shortcomings is their inevitably random nature, even greater than that possessed by ordinary trendlines, being restricted by extreme highs and lows, at least".

"In practice, not infrequently, several options prove available as regards inner trend line plotting procedure (see Fig. 14). Nevertheless, my experience advises inner trend lines to be of greater avail than ordinary trend lines when spotting potential support/resistance areas".

BRIEF CONCLUSIONS:

1. Each forex scholar offers his own interpretation of support/resistance levels, meaning different entities thereby (inclined, horizontal, inclined-horizontal, MA-based, round numbers-based, etc.).

2. There exists no clear-cut technique to define points to plot support/resistance levels through (except that of Demark's).

3. In real time trading, that said, these levels discovery on Forex charts automatically entails absolutely different conclusions.

Fig. 14. (For view picture see notes in end of article)

TESTING AND PRACTICAL INCONSISTENCY OF CLASSICAL SUPPORT/RESISTANCE DETECTION METHODS

Jeffry Owen Katz and Donna L. McCormick have disclosed results of their testing of the above scholars' recommendation procedures in their "Encyclopedia of Trading Strategies":

TEST PROCEDURE 2

A channel breakthrough-operated system. Closing prices are utilized only; next day market price entry at session opening; commission and slippage being accounted for.

The above test has been performed exactly the way the previous one, but with no account to slippage (3 ticks) and commission (USD15 per dealing cycle). Although the model displayed perfect operation with no account to dealing expenditures, it has turned out a complete fiasco in practice.

Even the best-in-sample solution has proved loss-responsible only, and, as expected, the system's beyond-sampling poor operation came into being.

Note: In compliance with E. Nayman's theoretical outlook, a channel upward breach is alleged to be a STRONG (!!!) trading signal at an uptrend.

TEST PROCEDURE 6

It is a closing price breakthrough system with next day per stop-order entry. The model longs via a stop-order at the point of breaching a resistance appointed by recent highs and shorts via a stop-order at the point of breaching a resistance appointed by recent lows.

As expected, the system exhibited much poorer operation with low profit and deteriorated statistics within sampling. The model proved killer to the per-deal average of USD798, with profit rating being 37%.

TEST PROCEDURE 7

The procedure involved volatility punch with next-day opening entry. The model longs upon next-day opening with provision that today's closing appears superior to the volatility upper edge. The model shorts in case of the price falling below the above edge.

The optimization period embraced 240 dealings only with 45% being profit-bringing.

TEST PROCEDURE 9

Involved is volatility punch triggering a per stop-order entry. The model effects a market stop-order entry immediately after passing a breach point.

The sampling period incorporated 1465 dealings, each being of 6-day average duration. The system has ensured 40% profit with average gain of USD 931 each. Under all parameter combinations only longs were winning. Both shorts and longs proved losing outside sampling limits. Only 29% were winning out of the total of 610 dealings.

BRIEF CONCLUSIONS:

Testing data, supplied by Jeffry Owen Katz and Donna L. McCormick, constitute convincing grounds that forex scholars' trading systems involving support/resistance breakthrough (the way these are described by the scholar) are rather likely to result in loss than in profit. This is one of the reasons for 95% of traders to turn their forex deposits killers.

In as much as the support/resistance related theory is so mixed up and subjective, it is only to be guessed what sort of support/resistance reading-matter may be offered by modern forex brokers' websites.