In this episode of 2Traders Podcast, Walter and Darren talk about the idea of support and resistance, its advantages and disadvantages, the dangers that might come along with using it, and why a lot of people are using it. Also, Walter and Darren touch about the topic of trendlines and how this relates to support and resistance and to a person’s trading behavior, in general.
Also, you might find out here how a children’s fairy tale can help you realize the main point behind support and resistance.
Download (Duration: 29:15 / 33.4 MB)
In this episode:
00:45 – ideas of support and resistance
02:32 – others just use patterns
04:36 – overriding belief system
11:25 – trading a subset of the pattern
14:08 – technical strategy
15:33 – support and resistance being popular
17:22 – magical thinking
18:30 – trendlines
23:00 – key elements
28:15 – your own analysis
People see patterns easily and see things that aren’t really there. [Click To Tweet].
Use your own analysis and stick to that rather than copy something else. [Click To Tweet].
It depends where you put your stop loss and where you exit. [Click To Tweet].
Walter: Because, I think what happens with a lot of traders is, they look at the one-hour chart to define their support and resistance. I would suggest rather looking at maybe the daily chart and finding those sweet spot on the chart where you’ve got repeated support…
Announcer: Two traders, Darren and Walter, pull back the curtain on profitable trading systems, consistent money management, and profitable psychological triggers. Welcome to the Two Traders Podcast.
Walter: Welcome back to the Two Traders Podcast. Walter here. I’ve got Darren on the line. Darren today, we’re going to talk about this idea, this nebulous thing that we see on the charts, this idea of support and resistance.
As you know, I’d drink the Kool-Aid, this is my thing. You can see this levels on the chart. I also admit that, as with a lot of things, we humans see patterns and so we have to be careful that it’s easy for humans to see things that aren’t there. It’s also quite true that, for a lot of traders, you can see these things everywhere. I’m trying to be pretty careful on how I draw these now.
I also think that, if I see them then I think that other traders also see them. It almost doesn’t matter if they truly exist or not. It’s like the “Emperor’s New Clothes” or whatever. If enough people go along with the gag, then it doesn’t really matter that he’s not wearing any clothes.
It’s like a self-fulfilling prophecy or whatever where if enough people see support and resistance on the charts, it doesn’t really matter if it exist or not. They’re going to react to that.
The other thing I should note is I am not one of those traders who says, “okay”. For example, as I was recording this week, the AUD hit a significant level of support and resistance that I’ve been watching for a long time.
Now, it came back and it pull back from that level so far but, I don’t just take a trade because the market has hit a level of support and resistance. It also has to show some pattern that I’ve tested, that I’m comfortable trading with. That I’ve seen the numbers that I believe in. It’s not just that “okay, there’s support here so I’m going to buy”. That’s not part of the deal.
Some traders I know will just do that. They’ll just take trades of support and resistance. Other traders I know would just use patterns. They just trade off the pattern. I like to see both line up that’s why I don’t trade as often as a lot of traders would like me to because I need to have both of those things lining up. That’s how I approach it. I know you probably have some different ideas.
Darren: That was the reason why I suggested we have a discussion about support and resistance today because it’s something you trade. Also, I’m interested in the whole thought process. Obviously, support and resistance levels visually when we look at candle charts are really appealing.
If you see spiky pattern, then price comes back and makes another spiky pattern and reverses there from the approach of one into trade successfully that, visually, it’s quite an enticing way to trade.
It’s probably one of the most, if not kind of, one of the most popular approach certainly in retail trading. I’ve heard a lot of banker institutional trades talked about price levels being significant.
I’m more interested in the mindset that goes behind it because, as far as I’m concerned, any support and resistance level whether it’s successful or not is relying on other fact as other than whether it’s support and resistance. It depends where you put your stop loss.
It depends where you exit, basically, is what I’m saying. It’s the exit ultimately that matters. Like you say, the AUD came to a strong support today. Well, if you put a two thousand pip stop on it, that’s essentially your exit at that moment. Then the win rate of that support and resistance level is going to go up, if you just trading it with ten or twenty pip.
That’s obvious and to you the overriding belief system is that a lot of other traders are going to recognize that level then, you’re going to add to that. You’re going to wait to see what the reaction is at that level to see if there’s any indication they’re buying or selling and then you’ll make your decision. Would that be a fair assumption of how you view it?
Walter: Yeah. Essentially, most of the things I test are crap and they don’t work out and they’re not something that I pursue. Most of the time, if I hear about an idea or someone says “Hey Walter, what about this? Have you ever looked at this?”, or I see something I know “Well, that looks interesting”, I’ll test it. I’ll run it through forex tester and that’s usually where it usually falls apart and I can’t make it work.
Like you say, most of the time, you can change it up a bit with the exit and that makes a whole heap of difference. I would go so far as to say — for those people listening who say “well, that’s a load of crap, it’s not the exit, try it, try it” — the best exercise I know to see this is to just flip a coin, heads by tails, sell and apply a really fat exit like Oanda four.
You’re risking a hundred pips to make four hundred or two hundred pips to make it eight hundred. Do something like that and get back to me after you’ve run that through a hundred and fifty trades. See how that works out because that, for sure, illustrates the power of the exits.
For me, the main thing I do is I look for those spots on the chart where the market has repeatedly reversed and then when it gets there, I’ll wait and watch. There’s one or two things that it can do — well, three things, really– the market can get to one of these levels and then it doesn’t give me a bullish or bearish patterns so I just do nothing.
Sometimes, it’ll get to the level and it’ll print a breakout pattern so it’s going to go beyond that level and it’ll suggest a breakout trade. In other words, continuing in the direction that it has been going.
Sometimes it’ll get to that level and it’ll print a reversal pattern. That suggest that I should take the opposite and assume that the market has going to turn around from that point even if it’s just a brief turn around. Doesn’t have to totally retrace the last months move but something like that would be expected.
So, that’s basically it. It’s the two pieces and to be clear — like I don’t think that it’s necessarily an easy thing to trade — for example, the one-hour chart using support and resistance because I think what happens with a lot of traders is they look at the one-hour chart to define their support and resistance.
I would suggest rather looking at maybe the daily chart and finding those sweet spots on the chart where you’ve got repeated support, repeated resistance. Then,, when you go down to your one-hour chart and , if that’s what you’re trading off of, so you’re trading the one-hour candle off of areas where daily the candles have bounced and repeatedly bounced.
That would be my suggestion. One of the big mistakes traders make is they see these things everywhere. It’s not necessarily the case that you’re going to see these everywhere.
If I’m looking at EUR right now and I see where the EUR bounced in April 2004 and then it came back to that same place and bounced in July 2005 and it came back and hit it again in May 2010. It came back again in July of 2012 and then it broke through the beginning of 2015 in January.
It spent many, many times where it hit it’s level and it turn around and, finally in early 2015, it stopped and it broke through. These are the sorts of things I’m talking about. It’s not like the EUR has hit this level fifteen times in the last forty eight hours. It’s more about really clear turning points in using in a hard timeframe.
What I’m saying is I think the mistake is to see too many of them. The mistake is to assume that “okay, I’ve got my support and resistance drawn on my one-hour chart. It’s up there. Now, it’s time for it to turn around.”
I don’t think that’s as reliable as using a weekly chart or daily support resistance and then trading the one-hour chart on that.
Darren: You’re obviously quite good at reading the price action and the movement from the pattern of the candle. Would you ever consider, then, just trading that and not adding the support and resistance?
Do you think that would be… ‘cause, essentially what you’re saying is, the support and resistance level is your interest. In other words, where price has made a sharp turn around. Is that right? Like a V-shape sort of quite distinctive?
Darren: Would you not consider just trading that shape appearing on the charts? The fact that it’s appearing is indicating that there is resistance there even though that you have predetermined it or looked back to see if it was before. But, just the fact that it’s making that movement in price indicates that there is support or resistance there and then trading that?
Walter: Yeah, it’s interesting. I know traders who’ve done that. One of our friends, Collin, he got really good at that where he just disregarded the support and resistance. He was always in so he’s taking these price action set-ups. He was always in. He was always long in short. It works well with him. I think he’s on his third hedge fund job at the moment.
That sort of thing might work. I haven’t been able to get it to work. To be fair, what I’ve found is that if I do this — besides my win rate plummets and I get really nervous — I haven’t been able to get it to work.
I suspect you’re right. I suspect there would be a way to do it. Obviously, it works for Collin and it doesn’t really work for me. I’m pretty picky, though. There are a lot of setups that looked really good to other traders that I won’t touch. I don’t know, maybe that’s just my bias.
I think you’re right. There’s a way that some traders can look into this and they can just trade the patterns. I suspect, however, that they’re probably trading a subset of the pattern.
For example, like maybe they’re trading a special case of pattern, the daisy. This maybe wrong but they might be trading a special case of the pattern and so what’s happening is they’re, in some way, they’re trading patterns that makes a lot of sense to them. They’re not really relying much on the support and resistance that may be there and as you say.
The problem I see is that you get too many of these in situations that aren’t good. Like, you might get a reversal pattern and then the market comes back up and gives you another reversal pattern, three candles later, something like that. They’re all sort of jumbled together.
To me, that suggests a break out, not a reversal. When you get too many candles that are sitting on a support and resistance level, by definition to me, that’s the market coiling up and getting ready to break through to the other side.
I haven’t been able to make it to work. I don’t know why. I just haven’t been able to make it work. I’ve tried that, tested it. I’ve tried but I found that I just get too nervous when my win rate plummets. It just basically means you’d have to adjust your exit, is what I’m saying.
You know what I mean? So, if you’re going to trade this where you don’t use support and resistance, you need to do something like what Collin did which is basically, he was always in. He was getting out of his trade when he got a reversal signal. It was sort of a trailing exit, wasn’t it?
What that meant was when the market is choppy, he was losing money, but when it was really moving and making it’s wild moves, he would lock in huge chunks of profit because he wouldn’t get out of his trade until he have a reversal signal.
Whereas, if I were using that same strategy where I’m just taking any of those signal I see, I probably end up making a losing strategy ‘cause my targets are too close. I’m not allowing those big swings to bump up my average winner. I think that’s probably what’s going on there.
Darren: I really like that element of using the higher time frame support and resistance then trading it on the lower time frame, really , because: one, like you say, it kinda forces you to wait. It stops you from trading too much when perhaps the reason. Iit’s making you to be patient, if you like.
The other element is that it forces you to trade with a bigger risk/reward as well. If you’re entering on a lower time frame and aiming for it the next daily support and resistance whether, statistically, it’s true or not. It is just forcing you down the road of trading for higher risk/reward.
That, in itself, can make all the difference to any technical strategy. I traded support and resistance for a long time. I really liked it and I’ve got into it really deeply but I can’t quite get it to fit.
I’m nearly… It was like the perfect thing for me but as I think about it, it wasn’t fit. I think in the end, it might well have been the fact that it’s so popular and that so many people are trading it. They’ve all got their own very strong belief on this is the right way of doing the support and resistance and this is the right way to trade it.
That for me was — the fact that everyone’s looking at it — was a negative for me. Eventually, I had to break away from that and so right when nobody else was doing it . If I did have to go back to trading support and resistance, I think I would use that higher timeframe support and resistance.
I probably wouldn’t tradeoff the levels. I’d be looking more to trade to them. If price was clearly in between two daily support and resistance and I’ve got some indication that it was going go to lower one, then I’d trade that to the lower one. I probably would check hedging on there, as well.
Walter: That’s funny. Why is it that you see support and resistance as being popular? Is that what a lot of traders are talking about or using on forums and things like that? I know our little community is pretty popular but, to be honest, I didn’t realized it was such a popular thing.
Darren: It’s pretty much universally popular now. Some people might name it differently but I find it very hard to find anyone that doesn’t mention support and resistance in some element of their trading now.
Although I don’t read a lot about other trading strategies now, but certainly when I did it was, I think it’s a combination of that if everyone else is doing it, then that gives you some validity.
The other one is it’s so visually appealing. You can pull out any chart and even if you’ve not mark the support and resistance levels on there, they’re appearing in front of your eye. That is a big factor as well.
Walter: Have you seen the heat maps where they… It’s some sort of weird indicator where it draws all the closing, prices are, something like that?
Darren: You can see that, anyway.
Walter: Yeah, exactly.
Darren: It’s like they’ve put this indicator on there and this is where lots and lots of trades are taking place. You can clearly see that anyway because price is resist going up and down, up and down, and up and down, going nowhere.
If you’ve got to put that there, somehow that is going to give you some added edge in looking for their levels of significance. Why can’t you see what’s going on here? They need this thing to believe in, don’t they?
Walter: Yeah. It’s like magical thinking where if it’s those red areas are on the chart, that heat maps on my chart, it’s like “okay, then I know that’s definitely…” It’s like this magical thing, this magical thinking. If I can put that color on the chart that I know that’s true, it makes it true because it’s on my chart.
Darren: The interesting thing that my highlight trade is doing at the moment is lots and lots of switch to single color candles. It’s been really good. It’s fascinating how little difference it makes.
Instead of having green for bullish candles and black for bearish, just made it black or green. It’s weird how these things seem so significant but when you take them away, it’s quite enlightening to realize, actually. I think my eyes are playing tricks on me more often than I like.
Walter: Yeah, that’s so funny. I’m just curious, what about trendlines? Do you think those are popular in comparison to support and resistance?
Darren: They’ve lost a bit of their popularity but I see more madness in trendlines or suggestive uses of trendlines than anything else. I see all that and, to be honest, some like bizarre crossing over lines that chop all through price then it comes out and price is suddenly back at the line. That is somehow significant and the high probability entry which is madness.
I really think a lot of it as madness. The logic behind the trendline is the price is going up and you’re going to draw a line in the sand and at that point you’re going to short, which is fine. That’s fine. If you think of it that way then, it’s perfectly logical valid way to trade. Then you’re ought to apply either large risk/reward or take your profits quickly and do it consistently.
The notion there at the point that it’s cross this line that you’ve drawn on the chart is now somehow significant. Even worse, it’s gonna somehow pull back and if it just touched the line that is somehow significant on any time frame. To me, it’s just madness.
Admittedly, I used to look at trading in that way. Now, when I look at that, I just think that that’s just madness.
Walter: Yeah, I don’t really see like where as in support and resistance. I think that, generally speaking — well, as if you’re looking at a higher time frame — you’re going to get some sort of agreement on about where they are at. On the weekly chart, they’re maybe like in eighty pips spread on average between where I draw at, where you draw at.
With trend lines, the crazy thing to me is everyone has different rules. It’s like, “okay, you’re going to connect the weeks, you’re going to connect closer, you’re going to connect three in a row or blah, blah, blah.” Or, “it’s going to be this angle”.
I never really know. I almost feel like I’ll look over my shoulder and I draw one cause I think someone is gonna slap me and say “you do it wrong.” I really don’t know the right way to do it. It seems crazy to me that people will argue the point that “no, no, no, you’ve drawn your trend line the wrong way”.
It’s almost like well, you’ve given your kid the wrong name or something. How do you know that? It just seems crazy to me. I agree, it’s a little bit bizarre. Then you have people who say “this is the high probability, like the marked trend lines and all this stuff.” I don’t know.
To me, once you start moving away from support and resistance you’re getting and even to the point of trend lines, you’re over complicating it. You’re getting away from… You’re adding just that other more complex part. When you add that part to an engine, it’s more of like it’s going to break down at some point. It’s definitely not my favorite.
Darren: The idea there is that you’re trading a reversal, anyways. You can visually see on the chart when a trend is occurring. It seems to me the most popular ones are like a nice, smooth trending price movement down or up. That’s like the preferred trend lines so I’d imagine I have a lot of actions there.
You’re looking at a point to look for the reversal. What I do like about the trend is this basic idea is that you look for a reversal but you don’t dive in too quickly. You’re waiting for it to actually move a certain amount and cross this line you’ve drawn before you commit to trading.
I suppose, structurally, that can have some good elements. Probably, as always if you think any of these time in for entries on their own, how can you see it through? I think you’re never going to make it. If you trade support and resistance on price action or anything at that, you need some elements that takes a lot of these. When you’re exiting, how much you’re risking where you’re placing your stop? How you’re managing your trades?
For me, those are all the key elements. When you are there, you can use whatever madness you want. That’s my approach. Not everyone, well very few people like to look at it that way but, that what works for me.
Walter: Yup, exactly. Just as when you say that, what that makes me think of is if you’ve got a system and you like the system but it doesn’t seem to work then, the area to work on is the exit. Where were you going to get your proofness is the exit, really.
Darren: Do you know or would you think that banks used support and resistance as well? Or is it the fact that the banks and the institutional traders are filling large orders at certain prices that is even, is wise form of resistance exist, anyway? That’s kind of the key element to them.
Walter: I would hesitate that to say “I don’t know.” I’ve heard a lot of interesting stories. Funny that you say that. My brother-in-law, actually, he worked at a currency desk and now he’s at a hedge fund. They let him have his own funds. He has this funds open since October, November so it’s been four months.
His funds is one of the best performing funds in the last four months because they’ve been shorting the markets. What’s funny is they don’t use any of that stuff. It’s interesting. The wide variety of the stories that I’ve heard that funds use is so bizarre you would think “no, there’s no way it ever work”. There’s no way you would ever do that and yet “yeah, I’m just using the twenty moving average”. You know what I mean?
Simple things like the banks have a huge advantage because they can just wait. They say “okay, Toyota is going to put this order in on for USD that’s coming through today. We know it’s going to move the market a bit so we’ll just slap our order in front of that.”
If you do that as a stockbroker, you’ll go to jail. That’s illegal. That’s front running but the banks do it all the time. That’s just good business practice. It’s a totally different world but from what I’ve heard, there’s a wide variety of techniques that the banks use. They’re also more flexible in how they get out of position.
I would refer the listener back when you’re talking about hedging. The hedging episode that you did was really good because that opens up your mind in terms of different ways to get out of a trade. Banks use those, too. I know that for a fact hedge fund is used. They’re going to use more options based on strategies.
They don’t necessarily have the same approach with a lot of a retail traders have. They do things that just seems crazy that you would just say “there’s no way that you can just trade off the twenty moving average. Make it work.” Or, you just wait ‘till there’s a rumor like “okay, General Electrics is going to put a big order on the EUR so we’ll just go in”. You know what I mean? Like it’s just this wild stuff.
What I’m saying, Darren is I have no idea. You know what I mean? I suppose it would make me feel better if I said “Oh, yeah. Wells Fargo and UBS and all these banks, they’re all using support and resistance, so I’m going to do it too but I don’t know if that’s true.”
Darren: I suppose, generally, they’re not really speculating like we are. Are they? They’re often just filling orders and making their commission and then obviously, try adding their little chunk on top. They’re coming on from a different point of view, aren’t they?
I say if you’ve got a massive order that they need to fill, then there’s no analysis that the company is doing. They just need to change EUR to USD. They want to get good price for it and they need to do it before the end of May or whatever. Those orders are not speculating on market movement like we are.
Walter: Yeah, exactly. You’re right. The other thing I would say is just because they’re the banks, it doesn’t mean that they’re right. Just yesterday, I saw a thing that said that one of the banks in Australia was saying that the AUD is going to go up two cents and there was nothing that’s going to stop it. Immediately when that report came out, the AUD fell two cents. It doesn’t mean that it doesn’t going to eventually get to where they said it would.
It just seems crazy to me that people look at what the bank say, or institution say, and say “okay, they’re doing that so I’ll do that too.” You’re better off to just do your own analysis whether it’s based on the RSI, or flipping a coin or support and resistance. It doesn’t matter. You’re just better off owning your own trades.
You can blame someone else if it doesn’t work out. You can say “well, I was following the National Australia Bank and they say the AUD is going to go up”. It’s the same thing with indicators. You can throw that indicator away, you can never use it again.
You can throw that advice away, that newsletter away, whatever you’re using. It’s healthier to use your own analysis and stick to that rather than trying to duplicates something else or piggy bank on someone else.
Well, thanks a lot, Darren, for your time. We will see you next time. Thanks.
Darren: Cheers, Walter! See you soon.