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Support and Resistance Homework

Support and Resistance Lines - Which are the most Important?
 

In last week’s live class, I gave you some guidelines to help you decide which direction the market should go and which support and resistance lines should be the most important. Time to see if you learned anything. ;-)

Take a look at the chart below. You may recognize it; however I’ve deleted the name and prices as I didn’t want those to throw you off of your analysis.

  • Question 1: Looking at this chart would you say prices are more likely to go higher or lower? Why?
  • Question 2: If you were going to trade this market now where would you place your entry and exit orders?
  • Question 3: Which support or resistance lines do you think will be the most important? Why?
  • Question 4: What would you say is the long term outlook for this market?
    •

Next week I’ll show you how I would have analyzed the chart and what happened in the market over the week.

Answer

As some of you figured out, last week’s chart was the daily for December Wheat. Below is the chart a week later with some annotations to it.

While the market was in a strong rally, the breaking of the RSI trendline signalled that we could see lower prices for the short term. Once the market could get below last Friday’s low (because that was the date that the RSI indicator was testing the trendline), I would have expected the market to retrace to the support near the 344 level.

Notice how this level is also near the 38% retracement as well as coinciding with the 20 day moving average. These two “tools” help us identify the support areas which are likely to be most important.

In this neighbourhood we can find three support areas which appear to be significant: 349, with 6 exact hits, although most of them are more than 6 months old; 344, with 7 exact and close hits, this level is also close to the 38% retracement and the 20 day moving average; and 339 ˝, with over 14 hits, if the market can make it through the other two support areas this one should hold it.

If we saw the market make lower prices (as we suspected) it would have to deal with each of these levels as prices declined. And since the market is currently in an uptrend this would have been considered a countertrend move and would likely not be very strong.

I would have given the most weight to the support at 344 since it had more recent support than 349 and was backed up by the retracement line and moving average line.

So what happened? The market gave us our breakout on Wednesday and promptly declined to…348 ˝, which is close enough to be considered the same as our support at 349. Surprised? You shouldn’t be.

We knew where to look for probable support, after that it was just a matter of finding the most significant support within that area.

Now I have to admit that given the strong close on Wednesday I would’ve thought the market would break the 349 support and continued lower to 334; however as you can see the market never got below the line and instead resumed the uptrend. Since this was a countertrend trade it would not have had enough profitability to make it worthwhile; besides it’s not a good habit to trade against the trend if you can help it.

Volume continues to increase with prices suggesting that the current bullish trend is still strong; however RSI is declining while prices are advancing. This is known as “divergence” and could be one clue that the trend is weakening.

But just because we have divergence does not mean that the trend will reverse immediately. In fact, given the strong uptrend I would think the market will try to reach the next upside resistance target at 374, which also happens to be the 62% retracement line on the weekly chart, or if it can manage through that, the resistance near the contract high of 380, where I would probably expect to see some sort of reaction or bounce.

 

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