Traders seek confirmation to improve the timing of entry and exit. Knowing that any signal can fail and mislead, all forms of potential confirmation are welcome. If you rely on candlestick formations, momentum oscillators, or chart patterns, you know all about confirmation signs. One you might have overlooked, however, is proximity of current price to the borders of the trading range.
Resistance and support define and give structure to current trends. However, these borders are more. They also enable traders to quantify volatility and to identify how and when the range is likely to change -- or when an attempt at breakout is likely to fail.
Traditional chart patterns often are aimed at recognition of reversal that takes place at the edges of the trading range. For example, double top or bottom, head and shoulders, or breakaway gapping price action, all test the trading range and are the most likely places where reversal is going to occur.
Combining this recognition of tendency within a trend with other signals can vastly improve timing. For example, when price edges toward resistance in an uptrend, or toward support in a downtrend, traders have to speculate about what comes next. Does the trend continue through the line and set a new trading range? Or does a traditional testing pattern evolve and then reverse to move in the opposite direction?
One approach to dealing with this unknown is to consider the resistance and support points as a form of confirmation. For example, as price approaches either of these, ask yourself these questions:
1. Is momentum weakening? If so, this point -- close to resistance or support -- is the most likely reversal point in the trend. If not, it is more likely that the trend will continue through resistance or support and (a) set a new trading range or (b) change the trendline to create a moving trading range.
2. Are moving average-based signals like MACD moving into new territory? The moving average as well as crossover (or pending crossover) are very revealing, and the lack of these signals is equally important.
3. Is the weakening momentum confirmed by other technical signals like RSI? This is an excellent form of confirmation too, but it has the greatest significance when the trend is toying with resistance or support.
4. Do candlestick reversal signals appear? When these appear at resistance or support, they have much more importance than during the mid-range trend. In a sense, the proximity of the resistance or support levels confirm the candlestick reversal. Equally important, if a reversal signal does not appear at all (or if you find a candlestick continuation indicator), then it is more likely that price is about to break out of the current trading range.
Michael C. Thomsett is an instructor with the New York Institute of Finance. He teaches five courses: “Swing Trading with Options,” “The Amazing World of Options,” “Synthetic Options Strategies”, “Options timing and dividend income strategies,” and “Using candlestick reversal and continuation patterns to improve timing.” He is also an investing and options author and has also written for FT Press’ Agile Investor series, which can be viewed on FTPress.com. Thomsett’s latest FT Press book is Trading with Candlesticks. He also contributes to the CBOE blog and to the Seeking Alpha blog.