Every now and then I get a question I just can’t answer, which is great because it gives us both an opportunity to learn. If anyone can help with this, I’d love to hear your thoughts. Please email me.
Here’s the email Q&A…
Hi again Lance,
I have a real question to ask as I really don’t know the answer and have been pondering it as one of my obsessions with trying to understand the market/s.
The question surrounds the basis for support and resistance prices but as I think about it, it can also apply to trend lines as well. And specifically, I am thinking about indices. I understand the notion of support and resistance with individual stock, futures and currency trading. They are unitary in that they are not comprised of any other combination of securities. However, thinking about an index like the S&P 500 or the Dow is a bit of a conundrum.
Consider: An index like the Dow or the S&P are merely a number of individual components mathematically weighted and summed to create a resulting value. In the case of the S&P there are ~ 2700 issues in this mathematical total called the S&P 500. Yet, one looks at these indexes as if they were a singular entity when in fact they are only a summation of the many individual elements. How is it possible and what is the mathematical basis for 2700 issues converging exactly in such a manner as to create a specific resistance or support level in the index given that each is only a component of the index and not all traders/investors, trade all of the issues in exactly the same proportion at the same time? Support and resistance levels may well apply to an individual issue but somehow, it doesn’t make sense that they all conspire to create specific and repeating support and resistance levels in the index to which they are only a part.
I hope what I expressed makes sense. It just is one of those fundamental understandings that have been bothering me and that I believe can apply to a better understanding as to why the support and resistance levels seem to appear consistently on the indexes. Of course, you can trade the DIA which is just a 100th of the DOW but it’s only a divided value of the DOW and thus inherits the same index properties. The same question applies here.
I have never heard this issue discussed or illuminated and I can find no discussion on the internet. Any thoughts?