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This article originally published in
the July 1999 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 1999, Technical Analysis, Inc.
 

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The Magic of Common Numbers:
     How To Identify The Crucial Support and Resistance Level at
     Any Market?

By Ned Gandevani, MBA, Ph.D.

Observing market movement tells us that price fluctuates from a level of support to a level of resistance. Understanding these support and resistance levels can help us enter, exit and manage our trades more effectively. But which support and resistance levels are the most important for our consideration? Looking at an intraday S&P price chart, you can find a multitude of these levels - and the market pays respect to some, while it completely ignores others.

Many different approaches are used to identify support and resistance levels in the market, but a great number of them are most unreliable. These approaches include, but are not limited to methodologies that utilize Fibonnacci numbers and ratios, trend lines, moving averages or Gann concepts. Those techniques have a static view of the market. Those approaches assume that the market will repeat its past behavior and experience in the same exact manner and can therefore be viewed with a linearly. They also bear fixed intervals for inputs which creates yet another problem. The market is not a static phenomenon and we cannot expect the market to disregard all the changes of economic and industrial Macroforces that constantly exert pressure on price movements.

The market is most certainly a Complex and Dynamic phenomenon - but it is clear that price fluctuates between levels of support and resistance. How can we identify these levels in advance and not in hindsight? This question was the main criteria during my study and approach to trading the S&P market. In this article, I’ll explain what levels of support and resistance are the most critical and how we as traders can identify them.


THE PSYCHOLOGY
First, let’s first review the psychological concept of support and resistance in the market. What does support or resistance mean and what is their significance to price movement? Support is a price level that exhibits a temporary fair value for the market. Prior to that level, Sellers sell the market because they view it as being overpriced. The market is pushed down to a level where Buyers step in with more money to hold price at the new level.

At that time, both sellers and buyers have made a decision regarding the overvaluation of the market based upon their individual systems of valuation. If the buyers now perceive this new level to be a good price for the market, they might flood the market with more buying pressure to hold the new level and eventually cause price to rise. In the case of a resistance level, buyers keep pushing price higher with buying pressure because of the good opportunity perceived with fair pricing. At perceived excessively high price levels, however, sellers enter the market looking for the opportunity to sell at inflated prices with higher volume, therefore creating resistance.

With this understanding of the basics of support and resistance, it seems logical that we should simply contact all of the available market participants, survey their opinions regarding fair pricing and then establish the most logical price values of support and resistance. This task is most unrealistic to attempt for obvious logistical reasons. However, a representation for all market participants would give us a clue as to the Common levels of support and resistance - that is, levels common to all participants.


FAIR REPRESENTATION
Looking at the Market Participant’s Universe, we are able to identify fair representations for all segments of the market. One way of segmenting the participant’s Universe is to use the Time Frame aspect. Since traders employ charts with specific time frames such as 5 minute or 15 minute bars, their particular levels of pleasure and pain (profit or loss) are represented on the simple bar chart. Therefore, our task is to identify the price chart time frames that most fairly represent the majority of market participants.

In the case of the S&P market, since such a high percentage of players are day traders, intraday charts will be sufficient for obtaining our information. For other financial markets or physical commodities, an understanding of the market dynamics is essential when trying to select the proper time frame to observe. Testing, research and examination are crucial when trying to select the proper time frame to employ. Based on my research of the S&P market, I have found the 1, 10, 30 and 45 minute charts as well as the Daily chart to be a fair representation of the participants. Note that a chart like the 10 minute time frame encompasses the price patterns of the 5, 7, 15, etc. so that each time frame listed includes a variety of different participants.

Now that we have identified a fair representative of the Market Participant’s Universe, we can identify support and resistance for each particular time frame chart and then find the Common denominators among the values recorded. Since a level of support or resistance is merely a price level in the market, we can therefore refer to it as a Common Number. Following is a Flow Chart to help you in identifying Common Numbers for the market of your choice. Please remember that the quantity of Common Numbers uncovered has a direct relation to the market’s internal dynamics. For example, when day trading the S&P market, most of the time four numbers are required to properly identify the most important support and resistance levels.
 

 

COMMON NUMBERS FOR EFFECTIVE TRADING

Depending upon the dynamics of a particular market, it’s possible to derive a number of Common Numbers. Each market’s dynamics will dictate a specific relationship between its Common Numbers, which will in turn limit their appearances within the context of intraday market extensions. We can therefore use Common Numbers to help locate better entry and exit levels for our trades.

Entry Points
You can identify a Common Number (CN) to enter the market, as price approaches the CN. This would result in a high probability of good entry with regards to price and time. Additionally, you might want to employ some type of dynamic indicator or particular price pattern to filter market noise from the CN level.
 

Stop Points
As the market makes its turn at a CN level, whether it’s support or resistance, the natural and dynamic stop level would be just a few ticks on the other side of the CN. If the market should happen to take out that particular level, it will most likely reach the next higher or lower CN level. Therefore, depending upon the dynamics specific to the market traded, you do not need to employ large stops for profitable trading.

 

Initial Profit Target
One of the most effective ways to identify an initial profit target, is to locate and employ the relevant CN’s since there is a high probability that the market will move from one CN level to the next. As the market approaches the next level of CN, the utilization of trailing stops can aid in maximum profit retention.

Exit Points
It’s natural to expect that after a trade is initiated the market will travel to the next corresponding CN level. Depending upon our insight and understanding of the market’s dynamics, you can easily anticipate the next level of market movement for exiting as well as new trade initiation at the CN’s turn around point. One may choose to exit and reverse with a new position counter to the initial trade.