Once broken, key areas of support will often act as resistance. Vice versa for key areas of resistance, which when broken will become future support. Let’s look at an example, of support becoming resistance. The beauty of this example is that it’s a challenging one from a trade management perspective (especially for people like me who actively manage their positions), so there’s a lot to consider in this example.
The chart below is a recent 3 min GBP/USD chart showing support (created by earlier price action) tested again at A and B, before breaking at point C. Previous support now becomes potential resistance, as price rallies up to point D.
Point D shows a rejection of the area of resistance. From a candlestick charting perspective, if you’re into that sort of thing, you’ll notice the bearish engulfing pattern, setting up for a possible short trade if price should break the lows of the pattern.
The initial stop would of course be placed above D. An initial target would be the area of the previous swing low F, and possibly further if you allow the trade to run. Those traders who prefer a fairly passive trade management style may operate exactly as per this plan, taking partial profits at F and trailing a stop on the remainder. And as we’ll see shortly you would have done just fine – this time!
Of course, the reality of markets is that the setups are rarely perfect, and trade management at the hard right hand edge of the chart is NEVER as easy as it appears in hindsight.
I prefer a more active style, so let’s have a look at how it might work from that perspective…
For me, there are a couple of real challenges with this setup.
The initial target only offers just over a 1:1 reward:risk ratio (which is fine by me, but I know many others require greater).
But more importantly, area E would quite likely offer some degree of support. I’d be very wary of that area. The move back up to D involved a change to an uptrend, so this ‘support becomes resistance’ trade is counter-trend. I’d be watching area E very closely for signs as to whether it’s offering just a small hurdle as price continues back downwards towards F, or whether it provides an impenetrable barrier leading to continuation of the trend upwards. This potential for E to offer support provides a less than 1:1 reward:risk ratio. From a 3 min chart perspective, I just don’t like the setup.
And as you’ll see in the next chart, E did provide some degree of support, pushing price back up to retest the entry three times.
Had I entered based on the 3 min entry trigger, with price breaking the lows of the bearish engulfing pattern, my active management style would likely have me exiting at breakeven, especially given the bullish look of the most recent return to the entry.
Of course… then I would have missed the move below. No problems though, I didn’t like the reward:risk, or the potential for E to provide support and lead to a trend continuation higher.
So, is there a better way to manage it.
While I aim to trade the swings on a 3 (or 5) min chart, I like to refer to a shorter timeframe chart to fine-tune the entry, management and exit decisions.
Let’s check out the 1 min chart below:
In this case, the 1 min offers an entry at a much better price than the previous 3 min entry. Sweet! And the beauty is that it easily provides a 1:1 reward:risk ratio for the initial target of E, with much more available down to F and beyond.
There are numerous ways you could manage this entry and trade, depending on your own preferences and your trading style. There’s no right or wrong – experience will allow you to determine your preferred trade management style. However, here’s a couple of options…
You might scale in a part position based on the 1 min scalp entry, entering the remainder at the 3 min setup entry. Taking scalp profits just before the support area E (which does provide a 1:1 reward:risk ratio) essentially provides your ‘3 min’ position with a bit of a profit buffer. If you do decide to scratch it, based on the three retests of that area then you’ll still achieve some profits overall for the trade sequence. Alternatively, you may be willing to allow the 3 min position to exit at a loss, giving back the scalp profits for a breakeven result overall. If so, in this example your exit would not have triggered and you would have achieved the target (as seen below).
If you prefer all-in entries, enter your whole position on the 1 min signal, aiming to scalp out part of the profit at the first support area E , then let the remainder target F. Allowing the second part to operate with a breakeven stop means that it won’t be hit at all and will continue down to F and beyond, as shown in the chart below.
Of course, with an active trade management style, you may well have taken profits on the second part during the sideways consolidation around area E. No problems – it’s still a profit on both parts. Move on to the next trade.
Ok. So that’s an example of support turning into resistance. But more than that – it also demonstrates via a real example that trade management is never an easy process for those of us who choose to actively manage our positions, and provides a couple of alternatives for improving trade results, through fine-tuning the entry on a lower timeframe chart.
Remember, it’s always easier in hindsight. But through reviewing trade opportunities such as this after-hours, comparing our decision making at the time with the hindsight-based optimal approach, we will gradually improve our decision making in real-time. That’s what the process of trading is all about… gradual improvement through effective review.
Active vs. Passive Trade Management: http://yourtradingcoach.com/trading-process-and-strategy/active-vs-passive-trade-management/