Support, Resistance and Trendlines

So today we are running through the foundations of technical analysis. Support, Resistance and Trendlines will haunt your dreams and give you false hope half of the time, but when they work you really begin to feel like you know what you're doing and they give you a lot more credibility when you're attempting to explain your trades to friends and colleagues alike.

Support:

Support lines are formed when a large number of (or very powerful) buyers are prepared to buy at the same price point. This results in the price bouncing up from that point and failing to fall through if in a downward momentum. The significance of a Support increases with each new bounce from the line, the distance the price bounces off the line is also an important factor in determining support strength. Although having said this, the stronger the support appears to be - the more dramatic the drop is once it fails.

A recent support line has shown up in the Corn market, although as the latest price points show this may have just failed.

Resistance:

Much like support, Resistance lines are formed when a large number or sufficiently powerful sellers all want to sell at the same price.

The graph below shows a potential resistance point that has just appeared in the London Cocoa market. The price has been steadily growing over the last year and appears to have come to a natural rest around the 3500 mark. Only time will tell how effectively this acts as a resistance point but this showcases a point at which you might start marking up a trade and looking for other factors to determine if or when you should enter the market.

Support and Resistance Lines can be helpful in determining where to place a trade's Stops and Limits. Many traders (particularly when starting out) will place stops as the maximum that they are willing to lose instead of based on price data.

Trendlines:

An upward trend is a series of consecutive higher highs and higher lows, with the trend line being drawn connecting a series of at least three higher lowers. The reverse is true for downward trends.

A strong trendline has more than three touchpoints, remains valid for a long period, and has a sustainable gradient.

I don't think that I will ever find again such a consistent and long-lasting trendline as the one shown below. The price of NY Cotton rose almost freakishly uniformly between April 2020 and September 2021, repeatedly bounding off a steady upward trendline.

However, while this trend follows the rule of having an enduring series of higher highs, the overarching trend does not achieve repeatedly higher highs in a uniform manner. In many cases, it can be helpful to think of the large trend line as being comprised of multiple smaller segments. If we look at the first third of the trend we can see that it obeys the rule of both higher lows and higher highs until the price grows more aggressively into a peak. It then settles back to the long-term trend but is heavily rejected, giving a smaller peak, before again returning to the trendline.

We can see that the price attempts to break through the trend line in the last quarter, receiving the strongest rejection to date and continuing to climb at a rapid pace away from the trendline. During its final connection with the trendline, the price actually closed below it which would normally signal the failure of the line. This nicely shows the conflict that is ever present with technical analysis. Following it rigorously provides many benefits but there are also cases where it helps to be a little bit more generous with the rules. It's up to you to form your own methodologies and opinions on when to hold out and when to obey the indicators over your gut.