Why is support and resistance important? People don`t pay much attention to the people and objects that play supporting roles. But, where would a house be without it`s support beams? Where would the leading actor be without his supporting cast? Well, the first one would be a wreck, and the second one, would likely be a wreck as well. Not knowing how to use a commodities support levels can wreck havoc in your trades as well.
Every commodity has support and resistance levels. A support level is a price at which the position has previously bounced and reversed a downward course. Think of it as a potential floor in the commodity`s prices. The reason it`s so important to set stops below support is that positions moving downward tend to bounce upward around their support levels. Afterwards they may begin to move downward again, breaking through support, and move even lower. A clear break below support is dictated by where a position closes, not by intra-day swings.
Alternatively, after bouncing off support, a position may continue to move upward, never returning to the support level at all. The one fairly specific rule in setting stop sells, the science part of setting them, is that you should not set them either right on the position`s support level or just above support. Instead, unless the support level is so low that stopping out there would loose you too high a percentage of your capital, set stops below support.
It doesn`t make sense to set a stop right at support because the position is almost certain to bounce up from that point, possibly reversing course. If you set your stop below support, it probably won`t be triggered unless the position has broken support and will continue downward. The key to setting stops that work is to use the support levels that exist for a commodity. The same principle applies for a stop buy-to-cover on a short position: Set your stop above, not at or below, resistance. A resistance level is a price at which the commodity has previously reversed its upward course. Think of it as a potential ceiling.
You can use resistance levels to help set your trailing stops by remembering that they often become support levels once they have been broken through. When the time comes to use trailing stops to lock in your profits, you can place your stop below what used to be the resistance level, expecting it to act like a support level.
What`s so special about the prices that act as support and resistance points? Is there something all the insiders know about the company`s valuation at those levels? Do they give some clue as to the real value of the company? Unfortunately, they don`t.
There`s absolutely nothing special about a number like 13 dollars or 65 dollars or any other price that is a support or resistance level for a commodity. They`re more like self fulfilling prophecies. Everyone in the market, from mutual fund managers to market makers to you, is looking at the same charts, and coming to the same conclusions.
Everyone expects commodities to bounce off support because the support and resistance levels are a price that is identifiable. The reason it has significance is because it is identifiable, and everyone reading the charts will identify it. Because everyone expects the commodity to bounce off support, it usually will.
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