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r/StockMarket – Technical Analysis Series (2): Horizontal Support/Resistance, Confirmation Candles, and Volume

Hey Gang,

Today I bring to you the second installment of the Technical Analysis Series: Horizontal Support/Resistance, Confirmation Candles, and Volume. Check out my profile for the first post on candlesticks if you are interested in this type of content and missed it (it’s one of my pinned posts). As previously mentioned, this series is geared towards the new trader who is trying to learn a bit about technical analysis.

I would classify this installment as a “super installment”, because a new trader can make great progress towards profitability and consistency by mastering these core concepts. I have been technical trading for a little over eight years now and I still use these concepts for every chart I look at and trade I put on. The reason I grouped these three concepts into one post is because they all operate together in order to be correctly applied. So let’s get into it.

Historical Horizontal Support/Resistance
Historical Horizontal Support/Resistance are horizontal levels on price that technical traders and algorithms will identify as areas of interest for buying support or selling resistance. As time progresses and these horizontal levels get tested more and more, they take on increased relevance as key areas of interest on an asset. Furthermore, once a resistance level is breached it will often be tested (wicked down into and bought up) and thereafter turn into support if upward momentum is to continue. Conversely, support will turn into resistance when the asset is trending to the downside. For my personal trading, these historical support/resistance levels take on even greater significance when they line up with major moving averages, high volume nodes, and/or Fibonacci levels (concepts that will be explored in future posts).

For those that missed the candlestick post, here is a crash course in what I’m talking about regarding wicks:

Here is a very zoomed out chart of Disney on the 3 day candle timeframe to illustrate horizontal support and resistance. There are quite a few more relevant support/resistance levels present on this chart, but I wanted to keep it clean so it’s easier to analyze.

The 3 day Disney Chart:

The arrows on the chart highlight when these historical support/resistance levels are tested. As you can see along the bottom of the chart, this chart covers price action on DIsney from April of 2013 all the way to the present.

The “historical” nature of these horizontal support/resistance levels is emphasized in the following shot, where you can see that price levels from five or six years prior are still getting play and being respected by the market:

General info on Horizontal Support/Resistance

  • Horizontal Support/Resistance levels work on pretty much any timeframe, however they will have more consequence, and be respected more, on higher time frames.

  • I generally apply historical support resistance levels off of the candle bodies (see candlestick post if you don’t know what a candle body is). This is because price can wick over and under a historical price level, but if not closed over by a candle body I do not consider the historical horizontal broken (this ties in with confirmation candles which will be discussed shortly).

Testing a Horizontal Support/Resistance
A close friend and mentor of mine explained technical analysis to me as the art of technical analysis, and this is a concept that has always stuck with me. Using these methodologies is not a science, and often a little bit of instinct and/or experience will make a big difference. Historical Horizontal Support/Resistance levels can and will be front run (i.e. bought up before the horizontal support/resistance) and/or overextended (i.e. sold or bought past the horizontal support/resistance). You do not always get a pixel perfect tap of that horizontal line. In the words of my buddy, “Close enough is close enough.” As will be further explained shortly, confirmation candle methodologies and volume analytics can be extremely useful when dealing with these types of close calls.For example, here is an example of where the major Historical Support level of Disney was front run. This can happen for a lot of reasons, and in this case I would say it was front run (not by much, only around $1.00) because it was such a good buy opportunity from a risk/reward perspective.

Nevertheless, I usually consider these wicks down to still count as tests of this Historical Support level. Close enough is close enough:

Two main takeaways/solutions for this type of price action that don’t quite make it to the horizontal are:

  1. A trader can layer bids slightly above, on, and slightly under a horizontal in order to spread out the average price of entry, and therefore catch at least part of this price action.

  2. A bounce or rejection off a horizontal like this, even if it doesn’t tap the horizontal straight on, can be taken as a sign that the level is being respected by the market.

Horizontal Support/Resistance w/ Liquidity Zone

  • Depending on the price action being analyzed, you can in some instances apply a second horizontal on the candle wicks, and this creates what is known as a “liquidity zone” between the candle body and candle wick.

    • Liquidity zones can be established by prior areas of narrow consolidation that have a lot of historical price activity.

    • A liquidity zone is an area that is wicked into and many bids are filled along this area of interest. Frequently, the price moves away aggressively from these liquidity zones for a variety of reasons that can be succinctly summarized: not everybody gets to buy the bottom or sell the top. When price does move outside the liquidity zone, it often does so in an explosive fashion.

    • Liquidity zones area a result of market dynamics and institutional order flow. Although beyond the scope of this post, the short version is that it is not a coincidence that liquidity zones are often established in the wicks right on the other sides of these historically significant candle bodies. Large institutions need liquidity to fill their sizable orders and they use the stop-loss orders placed right at the top or bottom of these candle bodies as a source of major liquidity to fill their bids. There is a lot to be said about institutional order flow and it will likely be expanded upon further in a future post.

For example, here is a major liquidity zone on Exxon established off 2 week candles that has remained an area of interest for over twenty years:

Why Horizontal Support/Resistance vs. Diagonals?
When technical traders are first starting out, I often see that they love to draw diagonals absolutely fucking everywhere.

Their charts often end up looking something like this:

& they start to look like, and probably feel like, this guy🙂 :

With a diagonal, especially one drawn out over an extended period, there becomes a wide range of where that diagonal support/resistance really is depending on where you are anchoring the first plot point and whether you are using candle bodies or wicks as the touch points along the diagonal trendline.

Diagonal support/resistances are valid and useful, particularly for things like rising channels, however for actual trading I will always see if there is a valid horizontal support/resistance nearby that I can use for risk management.

The reason for this is because I start every trade with the assumption that the trade will go against me. Therefore, I need to know my risk profile for each trade and when the trade will be invalidated. In my experience, a horizontal support/resistance level makes things much easier to know where and when to put on the trade and where and when to take it off if things aren’t going your way. In contrast, a diagonal support/resistance level may leave a trader unsure of whether the trade is really over/under that resistance/support level. Frequently, at least for me, this lack of confidence in the diagonal results in not taking the trade off where I originally intended. As a result, when the price moves further against you, the original risk profile for your trade is blown and you end up taking a bigger L than you wanted.

Confirmation Candles
A confirmation candle is how I tell whether a Horizontal Support/Resistance level has been broken.
There are two main ways to play confirmation candles and I use both methodologies depending on the current market dynamics I am observing:

  1. Close over/under “x” price:

    1. Using this approach you want the candle body to close over or under the Historical Support/Resistance.

      1. Here is an example of Disney Closing over a Historical Resistance:

  2. Open and close over/under “x” price:

    1. Using this approach you want the candle body to open and close over or under the Historical Support/Resistance.

      1. The benefit of this approach is that it adds further legitimacy to the critical area being breached and further prevents one from buying a “fake out.”

  3. Regardless of the candle confirmation methodology implemented, a trader still needs to manage the risk on his/her trades. As I have said previously, these tools don’t give someone a crystal ball into the future of the markets, they merely provide a statistical edge. Without proper risk management that statistical edge disappears.

Volume is another important tool that when combined with one of the confirmation candle methodologies above can give a trader increased confidence in his/her decision making around a horizontal support/resistance level and hopefully minimize the frequency of losing trades.
In general, you want the breach of a Historical Support/Resistance level to be accompanied by above average volume. When high volume accompanies the breaching of a key level it reflects that there is heavy market participation and a lot of action was done on the move. The benefit to above average volume being present during such a move is that it is much more difficult for an institution to be laying a trap during these periods. Further, it reflects that there is wide market consensus that this is the direction the asset should move.

The easiest way to tell whether volume is below average, average, or above average is to put a moving average on your volume indicator. I generally use a standard moving average length of twenty on my volume indicators, however I will sometimes adjust this depending on the timeframe or asset being analyzed.

Here is an example of volume being an additional confirmation tool on the breach of a Historical Support/Resistance:

Conversely, here is how using volume as an additional confirmation tool can keep you out of buying a fake out, even when using the more conservative open and close candle confirmation methodology:

So, as illustrated by the above examples, Volume can be a very handy tool when used in confluence with Historical Support/Resistance and Confirmation Candles.

On a final note, the methodologies outlined above can result in a trader missing trades because these approaches are too conservative to allow an entry in all scenarios. However, the markets present constant opportunities and a new trade is around every corner. Personally, I prefer to stick to rules such as those outlined in this post so that I can live to trade another day. Everyone is a genius trading savant in a bull market, but these tools may help a trader stay in the game when the tide turns. I hope this was helpful to all the new traders out there interested in technical analysis!

Follow my profile if you wish to stay abreast of future installments in this series.

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