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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