This article is a follow-up to the previous article I wrote on support and resistance. In the previous article I wrote about what causes support and resistance, how to recognise areas of support and resistance on charts using trend lines, the effect of those lines breaking, and the fact that support and resistance is most likely to be found beside 'round' numbers. In this article I am going to write more about actually trading support and resistance and the types of markets it is most effective on.
The most effective markets for trading support and resistance,
As I wrote in my article on different types of markets, markets are either driven mainly by speculation or by macro-economic fundamentals. As a general rule, markets that are driven by macro-economic fundamentals are good for trend following and markets that are driven by speculators speculating are good for trading using the effects of support and resistance, except, perhaps, when they are in the process of creating an irrational price bubble. Since the 1970's, speculation has become an increasingly important factor in the markets and on a number of markets the effectiveness of trend following systems has decreased whilst the effectiveness of trading using the effects of support and resistance has increased. On large liquid currency pairs (most notably the EUR/USD) macro-economic fundamentals like interest rates, politics, and the policies of the central banks of large economies still plays a far greater role in affecting the price than speculation does - it is not (usually) a good idea to try trading these markets with a system that makes use of the effects of support and resistance, these markets should be traded using a long-term trend following system, the best Forex trading systems are long-term trend following systems.
There are two types of markets that are driven mainly by speculation; they are, markets where the price is directly driven by speculation such as individual stocks and shares, and various commodities such as coffee and precious metals such as gold and silver. And markets that are aggregated derivatives of these speculation-driven markets such as the S&P 500 e-mini future where the price is driven by speculation but is also constrained by the underlying index (which it's self is just an aggregate of it's individual, speculative driven, component stocks). In my experience, these aggregated derivative markets are the best markets for trading the effects of support and resistance, and the worst markets to use trend following systems on. In fact, I would go as far as to say that trading the effects of the trend and trading the effects of support and resistance are almost mutually exclusive, the more effective one is the less effective the other will be.
How to trade support and resistance,
As with any other edge, the edge provided by the effects of support and resistance can be traded either with a mechanical trading system designed to take advantage of it, or a trader can simply look at charts and use his or her discretion.
The most common method of discretionary trading the effects of support and resistance is using charts and trend lines. The picture below is an example of how one may apply trend-lines to a short-term chart in order to trade the effects of support and resistance.
It's also fairly easy build a profitable mechanical trading system that takes advantage of the effects of support and resistance providing it's designed for an appropriate market. A mechanical support and resistance trading system works in almost the opposite way as a mechanical trend following system. A mechanical trend following system aims to buy on a new high, aiming to close the long position at an even higher price, or sell on a new low aiming to close the short position at an even lower price. Effective trend following systems are usually long-term ones. A mechanical system for trading the effects of support and resistance does the opposite. Effective mechanical systems for trading the effects of support and resistance are usually short-term systems that aim to buy on a recent low and wait for a new recent high to sell. One example of such a system might be the dips and peaks S&P 500 system. This system only takes trades in the direction of the long-term underlying trend in order to try and avoid catching falling knives during price bubbles, buys on a new 3-day low, and sells on a new 3-day high. It is very effective on stock market indexes, most notably the S&P 500.
