Resistance Is Not a Brick Wall

07/02/2015 6:00 am EST

Focus: STRATEGIES

Gregory Harmon, CMT

Founder and President, Dragonfly Capital Management

Many traders think of the concept of support and resistance as a brick wall for price, but Greg Harmon, of Dragonfly Capital, explains that most pros tend to view support and resistance more like a state border than a wall, a line of separation, but not one that can't be crossed.

The concept of support and resistance is probably the most misunderstood concept in the stock market. Most think of it as a brick wall for price. That makes it a great place for a reversal trade when price is hitting it. That is totally wrong.

I know what you are saying, "I see professionals scoping reversal trades at these levels all the time." That is correct. Many do trade for a reversal at resistance or support levels. But they do not do it because they see it as a brick wall. Instead they see these points of reflection as a place that has acted one way in the past. The actual support or resistance level then can be used as a stop loss for a low risk trade. They may be right or wrong and history suggests it is time to enter.

The key distinction between how the professional uses support and resistance is this concept of a brick wall. Pros see support and resistance more like a state border. It is a line demarcating a border, but it does not stop you from walking right through it.

Support and resistance are easiest to understand when they are exhibited horizontally. Through time, a specific price shows that it is important because it keeps showing up as a place where the price turns the other way. What it means in terms of buyers and sellers is that this particular price is an equilibrium point where both are willing to transact. There could be many reasons for that: they transacted there in the past, the stock was issued at that price, it makes for a 50% gain, who knows? This is a easy way to think about the concept.

A more difficult concept to understand is when support or resistance happen on a trending basis. A line connecting three (or more) low points continues to act as a reversal point for price in the future. The argument of prior price history does not hold up. In fact, there may be little or no price history, yet the point of the tangent of a line of bottoms or tops works. Why? I don’t know.

But I find this example as one of the best examples for explaining technical analysis to the novice. It is not that the point is expected to be support or resistance, but rather that it has become an important place to watch price action simply because it has shown to be important in the past. And it may or may not be important this time. If you can embrace this concept and just react to what happens, you are well on your way to becoming a good technician. For many this is precisely why they abandon it.

By Greg Harmon of Dragonfly Capital

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