How to Determine Where the Real Support and Resistance is Everyday

March 1, 2010

Understanding support and resistance levels is an extremely important skill in any market, and it's absolutely critical if you plan on trading the S&P and Nasdaq E-Mini markets. Professional Floor Traders are aware of an entire range of major and minor support and resistance levels before the market opens each day. They also know how to calculate new levels as the trading day progresses.

Knowing where the market may turn gives you an effective road map to guide you through the day.

Most traders calculate support and resistance levels incorrectly, and to make their job even harder, they generally don't know how to trade around them. Many traders will use an old high or an old low and assume they've found support or resistance. That just doesn't work. Think about it for a moment. If the market always stopped at old highs we could never have an up trending market, and if the market always stopped at old lows we couldn't have a down trending market.

These Are the Same Numbers Pro Traders Use Every Morning

Let's face it; we all want to catch the big trending days, days when the S&P moves 15 or 20 points without looking back. Unfortunately those big trending days just don't happen that often. Most days the market doesn't trend very much in either direction, instead it will move between known support and resistance levels.

Knowing the location of these price levels is important, but knowing how to trade around them can be the difference between success and failure. One of the simplest ways to do technical analysis is by using the pivot points. This method has been around for years and is described below:

A pivot point is approximately the center of today's price range. From there, calculate three different sets of highs and lows.
These pivots are then potential support and resistance, when prices have gone outside the Value Area.
 
            Pivot Point = (High + Low + Close) /3
            #1 high pivot = Pivot Point + (Pivot Point - Low)
            #1 low pivot = Pivot Point - (High - Pivot Point)
            #2 high pivot = Pivot Point + 2 (Pivot Point - Low)
            #2 low pivot = Pivot Point - 2 (High - Pivot Point)
            #3 high pivot = High + 2 (Pivot Point - Low)
            #3 low pivot = Low - 2 (High - Pivot Point)

This is Easy to Do By Hand Everyday, After the Market Closes, So You are Ready for the Next Trading Day

We do not use the pivot # for trading, only to determine the "sets" of pivots.  We do not use the #1 high pivot as support, if the market opens or trades above it, but use them as "envelopes".  Lets say the market opens above the #1 high, we'll look at the #1 low for support and the #2 high for resistance.

Generally, it seems that the #1 pivots work the best over time.  If the market gaps over the #1 pivot high, you'll have a #2 and #3 to work with.  You can either use limit orders to buy or sell at these pivots and use a money stop, or wait for the pivot to "hold" the market.  If the pivot "holds" the market, trade an engulfment, doji-star, tail or whatever you see, which is a more conservative entry.