I have always said that there is a lot of importance and potential in the trading of support and resistance levels in trading in general, and particuarly in forex trading. However it is true that the creation of long term profitable systems for automated trading based on the definition of S&R (support and resistance) levels has been difficult up until now due to the inherent problems of defining these levels mathematically. On todays post I want to talk about some of the approaches used to define these levels and the short commings each one of them has. On tomorrows post I will talk about what I think is the solution to the problem, a concept which may lead to the development of an automated system based on S&R levels which is able to gauge S&R level importance and trade the many techniques which can be derived from these levels in a profitable fashion.
So what is so difficult about the definition of support and resistance levels ? Theoretically a support or resistance level is an area (not a specific price value !) in which price finds a natural difficulty to continue to move in its previously acquired direction. So for example, if the EUR/USD is in an uptrend and there is a resistance level at the 1.3500 zone, price will get to this level and then it will bounce from it or consolidate around it until it either continues its previous trend or tests a lower support level.
Notice how many of the definitions of support and resistance are vague. What is a zone exactly ? how large must these zone be ? What parameters determine its size ? How could we know this level exists before price reaches it ?
The fact is that these questions have no straightforward answer. There is no rules for the size of the S&R zone, nor is there a way to accurately determine the levels before they happen. The previous attempts at coding automated trading system using S&R levels have tried to infere future S&R levels by taking information about previous levels in the past. The reality seems to be that a previously found support or resistance level will behave as either support or resistance in the future depending on from where it is attacked by price.
So the problem seems to be to find S&R levels in the past somehow and then use them in the future. If price faulters around a support or resistance level, then an intuitive way to define them is through the high/low criteria. A resistance is reached on the high of a candle followed by a candle of opposite direction and a support level is reached on the opposite situation. Another way to define these levels would be to use the fractal indicator. Since fractals determine patterns which signal reversals then the high or low of a fractal may indicate a resistance or support level.
The problems inherent to these very common approaches and other similar approaches is evident. All Support and Resistance levels are given and absolutely no importance is given to some over others. Another problem is that several fractals or high/lows may happen on similar levels but interpreted as different S&R levels when in reality they represent the same support or resistance zone. Since there is no discriminations between the S&R levels defined, these techniques of defining S&R almost always fail since they trigger trades on "not so important" price levels which make the strategies lack a positive mathematical expectancy.
So the steps to define S&R levels in a reliable fashion seem to be the following :
So what is so difficult about the definition of support and resistance levels ? Theoretically a support or resistance level is an area (not a specific price value !) in which price finds a natural difficulty to continue to move in its previously acquired direction. So for example, if the EUR/USD is in an uptrend and there is a resistance level at the 1.3500 zone, price will get to this level and then it will bounce from it or consolidate around it until it either continues its previous trend or tests a lower support level.
Notice how many of the definitions of support and resistance are vague. What is a zone exactly ? how large must these zone be ? What parameters determine its size ? How could we know this level exists before price reaches it ?
The fact is that these questions have no straightforward answer. There is no rules for the size of the S&R zone, nor is there a way to accurately determine the levels before they happen. The previous attempts at coding automated trading system using S&R levels have tried to infere future S&R levels by taking information about previous levels in the past. The reality seems to be that a previously found support or resistance level will behave as either support or resistance in the future depending on from where it is attacked by price.
So the problem seems to be to find S&R levels in the past somehow and then use them in the future. If price faulters around a support or resistance level, then an intuitive way to define them is through the high/low criteria. A resistance is reached on the high of a candle followed by a candle of opposite direction and a support level is reached on the opposite situation. Another way to define these levels would be to use the fractal indicator. Since fractals determine patterns which signal reversals then the high or low of a fractal may indicate a resistance or support level.
The problems inherent to these very common approaches and other similar approaches is evident. All Support and Resistance levels are given and absolutely no importance is given to some over others. Another problem is that several fractals or high/lows may happen on similar levels but interpreted as different S&R levels when in reality they represent the same support or resistance zone. Since there is no discriminations between the S&R levels defined, these techniques of defining S&R almost always fail since they trigger trades on "not so important" price levels which make the strategies lack a positive mathematical expectancy.
So the steps to define S&R levels in a reliable fashion seem to be the following :
- Define all S&R levels
- Discriminate important from unimportant levels
- Define Zones of S&R
On tomorrows post I will talk about how I intend to tackle each one of these problems and how I believe this will lead to the definition of reliable automated trading techniques based on S&R trading. If you would like to learn more about what I have done with automated trading and how you too can learn how to design and trade autoamted trading systems profitably please consider buying my ebook on automated trading or joining Asirikuy to receive all ebook purchase benefits, weekly updates, check the live accounts I am running with several expert advisors and get in the road towards long term success in the forex market using automated trading systems. I hope you enjoyed the article !
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