Now that you know the basics, it's time to apply these basic but
extremely useful technical tools in your trading. Because here at BabyPips.com
we want to make things easy to understand, we have divided trading support and
resistance levels into two simple ideas: the Bounce and the Break.
The
Bounce
As the name suggests, one method of trading support and resistance
levels is right after the bounce.
Many retail traders make the error of setting their orders
directly on support and resistance levels and then just waiting to for their
trade to materialize. Sure, this may work at times but this kind of trading
method assumes that a support or resistance level will hold without price
actually getting there yet.
You might be thinking, "Why don't I just set an entry order
right on the line? That way, I am assured the best possible price."
When playing the bounce we want to tilt the odds in our favor and
find some sort of confirmation that the support or resistance will hold. Instead
of simply buying or selling right off the bat, wait for it to bounce first
before entering. By doing this, you avoid those moments where price moves fast
and break through support and resistance levels. From experience, catching a
falling knife can get really bloody...
The
Break
In a perfect world, support and resistance levels would hold
forever, McDonalds would be healthy, and we'd all have jetpacks. In a perfect
trading world, we could just jump in and out whenever price hits those major
support and resistance levels and earn loads of money. The fact of the matter
is that these levels break... often.
So, it's not enough to just play bounces. You should also know
what to do whenever support and resistance levels give way! There are two ways
to play breaks: the aggressive way or the conservative way.
The Aggressive Way
The simplest way to play breakouts is to buy or sell whenever
price passes convincingly through a support or resistance zone. The key word
here is convincingly because we only want to enter when price passes through a
significant support or resistance level with ease.
We want the support or resistance area to act as if it just
received a Chuck Norris karate chop: We want it to wilt over in pain as price
breaks right through it.
The
Conservative Way
Imagine this hypothetical situation: you decided to go long
EUR/USD hoping it would rise after bouncing from a support level. Soon after,
support breaks and you are now holding on to a losing position, with your
account balance slowly falling.
Do you...
1. Accept
defeat, get the heck out, and liquidate your position?
OR
2. Hold on
to your trade and hope price rises up again?
If your choice is the second one, then you will easily understand
this type of trading method. Remember, whenever you close out a position, you
take the opposite side of the trade. Closing your EUR/USD long trade at or near
breakeven means you will have to short the EUR/USD by the same amount. Now, if
enough selling and liquidiation of losing postions happen at the broken support
level, price will reverse and start falling again. This phenomenon is the main
reason why broken support levels become resistance whenever they break.
As you would've guessed, taking advantage of this phenomenon is
all about being patient. Instead of entering right on the break, you wait for
price to make a "pullback" to the broken support or resistance level
and enter after the price bounces.
A
few words of caution... THIS DOES NOT HAPPEN ALL THE TIME. "RETESTS"
OF BROKEN SUPPORT AND RESISTANCE LEVELS DO NOT HAPPEN ALL THE TIME. THERE WILL
BE TIMES THAT PRICE WILL JUST MOVE IN ONE DIRECTION AND LEAVE YOU BEHIND.
BECAUSE OF THIS, ALWAYS USE STOP LOSS ORDERS AND NEVER EVER HOLD ON TO A TRADE
JUST BECAUSE OF HOPE.
Whoops, sorry about that folks, the caps lock key got stuck.
