why support becomes resistance

I am reading reminiscences of a stock operator for the umpteenth time. There is a lot of great information there however this one sticks out as something I have learned this time around. It can be seen as a follow up to the support and resistance levels observed in the post called the most hated rally ever and the problem faced in staring down the barrel of a gun.

Nobody should be puzzled as to whether a market is a bull
or a bear market after it fairly starts. The trend is evident to
a man who has an open mind and reasonably clear sight, for it is
never wise for a speculator to fit his facts to his theories.
Such a man will, or ought to, know whether it is a bull or a
bear market, and if he knows that he knows whether to buy or to
sell. It is therefore at the very inception of the movement that
a man needs to know whether to buy or to sell.
Let us say, for example, that the market, as it usually
does in those between swings times, fluctuates within a range of
ten points; up to 130 and down to 120. It may look very weak at
the bottom; or, on the way up, after a rise of eight or ten
points, it may look as strong as anything. A man ought not to be
led into trading by tokens. He should wait until the tape tells
him that the time is ripe. As a matter of fact, millions upon
millions of dollars have been lost by men who bought stocks
because they looked cheap or sold them because they looked dear.

The speculator is not an investor. His object is not to secure a
steady return on his money at a good rate of interest, but to
profit by either a rise or a fall in the price of whatever he
may be speculating in. Therefore the thing to determine is the
speculative line of least resistance at the moment of trading;
and what he should wait for is the moment when that line defines
itself, because that is his signal to get busy.

Reading the tape merely enables him to see that at 130 the
selling had been stronger than the buying and a reaction in the
price logically followed. Up to the point where the selling
prevailed over the buying, superficial students of the tape may
conclude that the price is not going to stop short of 150, and
they buy. But after the reaction begins they hold on, or sell
out at a small loss, or they go short and talk bearish. But at
120 there is stronger resistance to the decline. The buying
prevails over the selling, there is a rally and the shorts
cover.

The public is so often whipsawed that one marvels at their
persistence in not learning their lesson.
Eventually something happens that increases the power of
either the upward or the downward force and the point of
greatest resistance moves up or clown — that is, the buying at
130 will for the first time be stronger than the selling, or the
selling at 120 be stronger than the buying. The price will break
through the old barrier or movement-limit and so on. As a rule,
there is always a crowd of traders who are short at 120 because
it looked so weak, or long at 130 because it looked so strong,
and, when the market goes against them they are forced, after a
while, either to change their minds and turn or to close out. In
either event they help to define even more clearly the price
line of least resistance. Thus the intelligent trader who has
patiently waited to determine this line will enlist the aid of
fundamental trade conditions and also of the force of the
trading of that part of the community that happened to guess
wrong and must now rectify mistakes. Such corrections tend to
push prices along the line of least resistance.

A speculator must concern himself with making
money out of the market and not with insisting that the tape
must agree with him. Never argue with it or ask it for reasons
or explanations. Stock-market post-mortems don’t pay dividends.
Not so long ago I was with a party of friends. They got to
talking wheat. Some of them were bullish and others bearish.
Finally they asked me what I thought. Well, I had been studying
the market for some time. I knew they did not want any
statistics or analyses of conditions. So I said:
“If you want to make some money out of wheat I can tell you
how to do it.”
They all said they did and I told them, “If you are sure
you wish to make money in wheat just you watch it. Wait. The
moment it crosses $1.20 buy it and you will get a nice quick
play in it!”
“Why not buy it now, at $1.14?” one of the party asked.
“Because I don’t know yet that it is going up at all.”
“Then why buy it at $1.20? It seems a mighty high price.”
“Do you wish to gamble blindly in the hope of getting a
great big profit or do you wish to speculate intelligently and
get a smaller but much more probable profit?”

They all said they wanted the smaller but surer profit, so
I said, “Then do as I tell you. If it crosses $1.20 buy.”
As I told you, I had watched it a long time. For months it
sold between $1.10 and $1.20, getting nowhere in particular.

Well, sir, one day it closed at above $1.I9. I got ready for it.
Sure enough the next day it opened at $1.20-1/2, and I bought.
It went to $1.21, to $1.22, to $1.23, to $1.25, and I went with
it.

Now I couldn’t have told you at the time just what was
going on. I didn’t get any explanations about its behavior
during the course of the limited fluctuations. I couldn’t tell
whether the breaking through the limit would be up through $1.20
or down through $1.10 though I suspected it would be up because
there was not enough wheat in the world for a big break in
prices.

As a matter of fact, it seems Europe had been buying
quietly and a lot of traders had gone short of it at around
$1.19. Owing to the European purchases and other causes, a lot
of wheat had been taken out of the market, so that finally the
big movement got started. The price went beyond the $1.20 mark.
That was all the point I had and it was all I needed. I knew
that when it crossed $1.20 it would be because the upward
movement at last had gathered force to push it over the limit
and something had to happen. In other words, by crossing $1.20
the line of least resistance of wheat prices was established. It
was a different story then.

I remember that one day was a holiday with us and all our
markets were closed. Well, in Winnipeg wheat opened up six cents
a bushel. When our market opened on the following day, it also
was up six cents a bushel. The price just went along the line of
least resistance.

What I have told you gives you the essence of my trading
system as based on studying the tape. I merely learn the way
prices are most probably going to move. I check up my own
trading by additional tests, to determine the psychological
moment. I do that by watching the way the price acts after I
begin.

Here are the price levels I noted last week:

I wish I had stuck to my guns and stayed short from 1250 but the return of the bull market seemed so convincing!

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3 thoughts on “why support becomes resistance

  1. Hey toast!

    Yes support often becomes resistance, but like everything in trading, this is not as clear-cut as the textbooks are trying to make it look, otherwise it would be too easy, just sell a break of support and go home rich. It certainly helps to know *what* made the support act as support to have some sort of hypothesis as to what to expect next, including what to expect if the market does not stay below that broken support.

    As I am writing this, we have broken the magical 57.50, retested is from below and jumped of a cliff…here is your support becoming resistance. Jesse would love this…

    But hey, don’t kick yourself for not holding for 100 points, lol. In this environment one good news can be a game-changer. For example, if Merkel finally gives in to the Eurobond nonsense, shorts could get slaughtered in an epic liquidity rally. But that’s on a side note. What I want to say is it could have gone the other way just as easily. Personally I don’t have the slightest ambition to swing trade a historically complex global financial crisis where no-one knows what to do the next day, week, month. Instead, I try to focus on the next 10 minutes and the 3 point rotation based on my levels (which of course brings us back to support and resistance!)

    Benko

    • hi Benko, that is a great comment, thank you.

      Indeed if it was that easy then everybody would be rich. The book where I saw the first image described it as something like a pane of glass. Price can rest on it but if it gets hammered a lot there is no way it can take it and will eventually crack.

      I see why you said 1157.5 – it is the equalized 1163 (for others info, the volume point of control for the index for the last 3 years). It provided the support for the first bounce in August.

      Regarding the 100 point swing I like what you say about an era defining crisis. It is so news driven that a massive jump can happen so fast. We had some German commentators on TV last night and they were calm and think everything is ok. They point to the fact that Europe is still in far better shape than the US, I guess we still have not really had a Lehmans moment here (seems almost every bank is too big to fail).

      toast

  2. pivot points with a volume profile twist

    As prices get inefficient by trading at the outside part of this curve (Figure 1), it is almost always more profitable to (a) look for a range-bound market instead of a trending session – because a greater percentage of days are range bound, and then to (b) exit at the pivot as most traders are looking to initiate trade and volume picks up.

    http://www.sfomag.com/ArticlePrint.aspx?ID=573

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