Welcome back to another installment of support and resistance.
The main chart features that I’m looking for in identifying support and resistance areas are the swing highs and lows, and areas of congestion. These have been covered in previous articles. If you haven’t seen them, please review them first:
1 – Support and Resistance – The Greatest Trading Tool
Today we’re going to have a quick introduction to another feature of the market which can lead to the development of support or resistance areas – round numbers. In analyzing a market, I never use this as a stand-alone method of finding support or resistance levels. Rather, it’s a factor which will simply increase confidence in an area already identified as support or resistance.
However, once you know to look for this, you’ll be amazed at how often a round number does seem to act as a barrier to price flow.
What do I mean by round numbers? Rather than develop a rule, let’s just look at some examples and it should become fairly obvious.
For a highly priced stock, it might be price in the region of $70, $80, $90, $100, $110 etc, or any multiple of $10.
For a mid-priced stock, it might be price in the region of $25, $30, $35 etc, or any multiple of $5.
For a low-priced stock, it might be any multiple of a dollar, such as $7.00, $8.00, $9.00, or even multiples of 50 cents, such as $5.50, $6.00, $6.50 etc.
For the penny stocks, you might look at multiples of 10 cents, such as 0.10, 0.20, 0.30.
Forex? Yeah, it works here as well. GBP/USD at 1.9600, 1.9700, 1.9800, and even the 50 levels 1.9650, 1.9750, 1.9850.
In fact, this concept applies to any market.
An important point before continuing – you’ll recall just a few paragraphs earlier that I said I don’t use this as a stand-alone method of finding support and resistance. If you did, you’d end up with a grid of evenly spaced horizontal lines all over your chart that would just get in the way of price. Rather, I use round numbers as:
- A means of increasing confidence in the support or resistance areas already found at swing highs/lows or congestion areas; or
- If there’s no evidence of past support or resistance through swing highs/lows or congestion areas, then it simply provides a warning area. For example, if I’m long in a trade and it’s seriously overextended to the bullish side and approaching a round number area, I’ll expect some profit taking at this area and therefore potential resistance. So I might choose to lighten my position, or tighten my stops.
How do round numbers become support or resistance?
Round numbers work simply because human nature has led to them becoming significant. We work best with approximations.
You hear all the time people making comments such as, “If stock XYZ gets down to $10 that’s a bargain, and a definite buy”, or “There’s no way stock ABC will get over $75, so if it gets up there I’m going to take profits.”
Note that they don’t say that XYZ is a bargain at $10.17, or ABC is oversold at $77.63. We work better with round numbers.
This will lead to a greater proportion of orders to buy at or around the XYZ $10 level, and a greater proportion of orders to sell at or around the ABC $75 level. And it’s these orders that increase the likelihood of $10 becoming support and $75 becoming resistance.
You hear this in all markets.
There was great talk in the previous twelve months, about GBP/USD rallying up to the 2.0000 level, and USD/CAD falling to parity at 1.0000.
Remember, this talk doesn’t guarantee support or resistance at these areas. However, it should act as a warning of a potential barrier to further price movement.
Let’s look at some examples, from different markets and different timeframes.
In the daily chart of the Energy Sector, XLE, note how the price met support at the 70 round number level (area A). The price rally stalled briefly at 80 (area B), before topping at resistance at the 90 level (area C). After failing to breach this resistance area over the next several weeks, price fell and met support briefly at 80 (area D), before returning back to support at the 70 round number level again (area E).
The hourly Euro/Yen chart above shows support at the 168.00 level (area A) rallying right up to the 169.00 level (area B). The last red candle in the topping pattern gave a breakout above the 169.00 level by 17 pips, which quickly failed and led to price falling right down to support at the 167.00 level, initially 6 pips short (area C) and then only 2 pips beyond the level (area D). That’s close enough for me.
And it works on the short timeframe charts as well.
The 5 minute e-mini Dow chart above, shows the open on Aug 16, 2008, rallying up to the 11700 level (area A). Price reversed and fell to a low at the 11600 level (area B), where it then rallied up to retest the 11700 round number three more times at C, D and E.
The 5 minute e-mini Dow chart above, shows the open on Aug 20, 2008, falling to test support at the 11300 round number zone (area A). Price rallied, stalling briefly at the 11350 level (area B), before continuing on to the ultimate high at the 11450 zone (area C). Ok, 11452 to be exact, but who’s counting. Remember, we’re talking about support and resistance zones, not exact numbers.
Now as much as this sounds like the greatest discovery since sliced bread, I just want to remind you (yet again) it’s not the Holy Grail. In the above example, price found support or resistance in the vicinity of 11300, 11350 and 11450. However it didn’t have any difficulty breaking right through the 11400 level.
Just because price is at a round number, doesn’t mean it will pause there.
As I said in the introduction to this article, in analyzing a market I don’t use this as a stand-alone method of finding support or resistance levels. Rather, it’s a factor which will simply increase confidence in any area already identified as support or resistance.
I prefer to look for levels of support or resistance through swing highs and lows or congestion areas, as described in previous articles. And then if they coincide with a round number, all the better.
Had I traded the above example, 11300 and 11350 would not have been considered significant in my pre-market analysis. However 11450 was proven as a previous area of significant swing-low support, on two occasions about a week prior. Being a round number as well adds to my confidence in this level again acting as a potentially significant area of support or resistance.
First of all thanks.
I have started reading your blogs from the very beginning (the Holy Grail) few days back. As i finished this blog, i noticed that you had forgot to write “Support and Resistance 5 – Gaps”. Didn’t you?
Gaps definitely act as great areas of potential S/R. To be fair though, they could fit under the definition of swing highs/lows though. 🙂