One of the best ways for beginners to get their feet wet is by learning how to trade support and resistance levels.
That’s because traders who don’t know much about the stock market often begin with advanced techniques that can land them in hot water — and fast if they’re not careful.
I posted an article about market cycles and how they alternate between trending and range-bound.
If you missed this article, click here to check it out because it’ll help you match the correct trading cycle to your strategy, greatly increasing your odds of success.
How to Trade Support and Resistance Levels: Wait Till the Trend Ends
The first thing you want to do when learning how to trade support and resistance levels is identify the correct market conditions that lend themselves to range-bound trading.
The biggest mistake beginners make is trading range-bound techniques when markets are trending higher or lower.
The key is to monitor trending stocks and wait till the trend ends.
Once the trending cycle ends, markets usually enter a prolonged stage of consolidation — or range-bound activity.
In other words, make sure you start out by monitoring trending markets, and don’t enter them.
In the example below, you’ll notice I’m monitoring and waiting for the trend cycle to end.
If you continue to monitor specific stocks or other markets such as futures or commodities, you’ll notice how the trend becomes weaker. Eventually, the market enters a different type of trading cycle (also commonly referred to as a “regime”).
This is the correct time to initiate support and resistance trading tactics because the longer the market stays in one cycle, the longer it’s likely to stay in the next cycle.
In the next example, you can see how Devon Energy Corp. (NYSE: DVN) slowly transitioned from trending to range-bound cycle.
How to Take Advantage of a Range-Bound Trading Cycle
When you isolate a range-bound cycle, you want to make sure to give it a week or two to develop so you can see if there’s any directional bias.
In the simplest terms, you want to see if the range-bound cycle has a directional slope.
Even when markets are range-bound and trendless, there’s usually some degree of directional movement it has bias toward.
This bias is typically a sign that the consolidation is a reversal and, more often than not, the range-bound price action leans in the opposite direction from the previous trending cycle.
You can see in this example below how the stock favors the upside move. The previous trending cycle was downward, so it’s not surprising for the range-bound cycle to lean in the opposite direction.
After you isolate the range-bound cycle and determine which direction the market is leaning, you can begin planning your entry and exit levels.
The best opportunities tend to occur when people take trades in the direction of the slope the market is leaning toward. This tip will increase your profit-to-loss ratio as well as the size of your winners.
How to Trade Support and Resistance Levels: The Second Example
To help you get a better understanding of how to trade support and resistance levels, and get a good idea of which direction to take your entry and exit signals, I want to provide you with another example…
Take a look at this chart of Goldman Sachs Group Inc. (NYSE: GS)…
You’ll notice how GS has been trending upward for an extended period of time.
Monitoring stocks trending in one direction is a great way to begin your analysis. And market cycles tend to alternate, so you can anticipate with a high degree of certainty that a trending phase will end and consolidation cycle will begin.
Once you find the right stock to trade and notice its trend is coming to an end, you can begin looking for range-bound trading to begin.
The next step is to isolate the range-bound trading action and see which way it slopes…
You only want to take trades in the direction the market is sloping, so give it some time to show you which way to position yourself.
Once you isolate the range-bound cycle and determine which direction it favors, you can begin to plan your entry and exit.
In the next example, you can see how the slope is trending down, and my entries are always in the direction of the trend or slope.
Things to Keep in Mind
Range-bound cycles work well with support and resistance trading patterns.
Make sure you pick stocks that exhibit substantial volatility and trading range, and don’t forget to only trade in the direction of the slope!
This will prevent many false signals.
Let the channel develop before you enter so you can get a good idea of where support and resistance will line up.
I hope this article on how to trade support and resistance levels helps!
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All the best,
Senior Strategist, WealthPress