Jan

16

Resistance/SupportThe concepts of support, resistance and pivot points became such widely accepted market concepts that one is amazed how every market book mentions them freely as if the reader is supposed to know what they mean and how they should be traded.

In Alchemy of Finance, even the philosophic palindrome mentions them in his real time experiment and how he trades them. Same with, dare I say all the immortals including Paul Tudor Jones among others.

Now, I will not debate the validity of these concepts nor will I question the wisdom of the immortals here but I have a very genuine question about applying these ideas to indices.

You hear all the time that the (pick your index), let's say S&P500 hit a major support (pivot) point that should be watched very closely and if broken will signal the beginning of the bear market. A statement one hears frequently nowadays.

Now, if you consider that the S&P is made up of 500 companies, these 500 companies have each their own support and resistance levels that are tradeable in the same manner as the index, doesn't that mean that the S&P500 index resistance and support levels really reflect nothing and only represent arbitrary numbers that reflect where its components are at, and that the main premise of pivots, support and resistance levels on the index is a faulty concept?

In other words, if we take the extreme case where all the 500 companies are trading at a support level, this doesn't necessarily mean by definition that the representative index is trading at a support level on the chart. It can be trading at one arbitrary point on the chart with no significance to a chartist. Yet, this point is indirectly significant since it represents a colllective support (all the 500 companies are at a support level).

The other extreme case is where none of the companies is trading at a support level but the S&P is trading at what chartists call a support. In this case, what is the significance of the support level of the index (or the pivot point), if all the components of the index are trading in the more fluid level of no support.

For the sake of public disclosure I do not believe in support or resistance levels but am trying to get educated on how the other side thinks so one is well prepared to react or even change one's mind in extreme situations.

Larry Williams chimes in:

I am a doubter of support and resistance, but I am a user or short term highs and lows as they can be mechanically constructed and tested.

And, furthermore, even something that does not work (in my book that would be Support/Resistance, Fibonacci, etc.) may be of value if it forces a trader to use those points as stops or targets. At least you have an approach and something that says get out; limit your losses, or well enough; take profits. Yes, even if they are meaningless they can be of value if they add some form of discipline.

Steve Leslie offers:

I agree that the indices are fluid and not static. Individual stocks are added and subtracted all the time. Therefore it is quite difficult to draw conclusions based exclusively on this and across time. This is akin to comparing athletes across different generations. However two points can be made. First, they can be a good indicator of the general mood or tenor of the particular market that one is studying. The psychology if you will. And the psychology of the market is very critical to performance. Second, If one studies the overall market, one should study the various submarkets as well. The S&P 500, S&P 400, Transports, Utilities, Russell 1000, Russell 2000, NASDAQ, Value Line, Wilshire, etc. A composite can develop. A pastiche. Remember that as in all things, trading is a business of imperfect knowledge and imperfect information. Therefore nothing is absolute. Better to err on the side of caution at times and try not to extract too much from something that can not provide it. As we know, even the very exceptional traders have tough times and lose money. The key to trading is money management.

Eric Blumenschein writes:

The S&P financial contracts are traded for different reasons then the component companies that make up the S&P Index. I know it is obvious but it has not been stated yet. Certainly there are correlating movements some of the time and with some companies and often a lot of the time with a lot of the companies, but in the absence of a definable edge which may already be in use in some blackbox algorithm, it's all just noise. I suppose an edge worthy to explore for me as a daytrader is to know what percentage of the 500 companies currently register on some intraday interval, either above or below their previous day close. That may or may not be relevant to a trade I would take on the S&P eminis. It may make a difference to equally weight each of the 500 companies or slant the weighting to the largest ones or perhaps the smallest ones. If I was a position trader then perhaps there should be separate percentages to defensive issues vs speculative ones. That may or may not be valuable. 


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3 Comments so far

  1. Lon Evans on January 16, 2008 6:53 pm

    The reality that many who subscribe to the opinions bandied about on this site seem ignorant of is that all indicators (including support and resistance) are little more than just that, indicators. And what do they indicate? Nothing more than what provides the basis for any market one might refer to in the history of man.

    Yes, man. As in, markets are men. Indicators are merely a way of seeing men. For a particular individual, one indicator may make more sense than another, therefore that individual subscribes to that indicator. Unfortunately, such subscription rarely occurs without an emotional commitment as well. Here is where the trouble starts.

    I’ll use the proponents of Vic’s philosophy, those enamored with this site, as an example. Let’s call them the NUMEROLOGISTS. Everything is numbers, the manipulation of, the stretching of, the compression of, the tortuous circumlocution of…, oh, what wicked things they do to these poor symbols.

    And in doing so become blinded by a particular arrogance, based upon an unquestioned assumption. Rather than letting the numbers be defined by men, these practitioners attempt to define men by numbers. This will work only so long at there is tacit acknowledgment by a majority that such an approach is valid. When the herd abandons a particular philosophy, its proponents take a beating, i.e., Vic’s experience over the summer.

    Support and resistance are likewise, merely, indicators with enough acceptance as to be of importance to the market player. You don’t have to be “right,” you just have to convince enough people that you are. The herd will take care of the rest, and you will benefit. In other areas of study its known as a Cult of Personality. An indicator is important only in proportion to the depth and breadth of its proponents. This is something the NUMEROLOGISTS seem woefully ignorant of. Thus this post appeared at all.

    In short, get your heads out of the clouds and take a gander at the brute who stands next to you during your morning commute. Come to understand him, and so many others like him. Only then begin to formulate an indicator, and do make sure that he figures squarely within its confines. You’ll do just fine.

    lon

  2. Gene Gard on January 16, 2008 9:35 pm

    As a technical agnostic myself, I would suggest that perhaps there is some truth to support levels as self fulfilling prophecies. Perhaps each of the 500 S&P stocks have support points that are occasionally danced around in a statistically significant way, and the exchange as a traded derivative itself has similarpseudo-support from technicians at some level– levels that may or may not be approximately the weighted average of the constituent substrate of securities.

    Sounds like a counting project to me… but the technicians would have to agree on precise definitions of support levels!

  3. Ronald Weber on January 17, 2008 1:26 am

    Even if Support and Resistance are not supported by scientific evidence and make little sense at first (as demonstrated by Hany Saad) it is difficult to deny that, at least in the short-term, they are relevant factors for many system traders/funds, derivative products, structured products (that often get their trigger at round number levels) and can become self-fulfilling prophecy. For some mysterious reason the 12'000 for the Nikkei during 2003-2005 was a hard nut to break and it became naturally an important reference point (until it broke it in summer 2005); Gold at USD 1'000 or oil at USD 100 are also significant from a collective behavior view as they send a signal to the investors psyche, get all the news headlines and make their way into non-investors discussion topics as well, maybe it also trigger a visit of Bush and Sarkozy to the large Oil producers. So, eventually these critical levels become a reference point that affect real events.

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