Resistance Become Support

Resistance then Support

Moving averages that have shown to be resistance previously and are breached will now become support in a new uptrend. This basic rule works very well with the moving averages. The candlestick signals help with a visualization of that phenomenon. The analysis of what is happening at a moving average becomes a function of which signals are occurring at those levels. This makes trading in the moving average area very simple to analyze visually.

Another common technical analysis rule is that the first time a resistance level is touched, it will usually fail. The only subjective word in that rule is “usually”. If this first attempt failure is a general rule, then being able to visu­ally see what is happening at that resistance level produces a better insight. A candlestick signal that shows weakness at the point where crossing a moving average is first attempted creates a much different analysis than if the candle­stick formation is a strong bullish candle that blasts through the moving aver­age. Although this may seem simplistic, the signals reveal what the investor sentiment is at those levels. Improving the probability factor of this pattern can be easily applied by knowing the signals that occur at that level.

The probabilities are greatly enhanced when an investor can anticipate where candlestick signals should occur. For the aggressive trader, selling all or part of a position when a price encounter one of the major moving averages, anticipating that a candlestick signal could occur, creates a highly profitable low-risk trading program. Highly profitable in the sense that an investor is buying or selling right at a major support or resistance level. If the trade works as expected from that level, an optimal entry price was probably obtained. For the option trader, buying on an extended move down that just barely touches the lower major moving average allows options to be bought at a low price and probably with a minimal amount of option premium built into the price. The risk of this aggressive approach is that the downward trend does not stop at that support level. However, the point of the trade was that a downtrend stretch­ing to that support level had the probabilities of acting as a support. If the price does not hold at that level, then the trade would be closed immediately, limit­ing the loss.

On the other hand, whether buying the stock or the option, it may have been bought at the most optimal price before the reversal signal appeared. Again, in the case of an option trade, this aggressive approach would have a double benefit. The price of the option will be low and the premium will have diminished. As the price starts to move back up, the premium will expand as confidence builds back up.

If moving averages are used as support and resistance levels, they will be quickly confirmed upon viewing a candlestick buy signal at support or a candle­stick sell signal at resistance. The possibility of a moving average becoming a target becomes enhanced when analyzing candle formations as price approaches a target. For example, viewing candlestick bodies getting bigger, creating large black candles after a downtrend has been in existence for a good while, or seeing a gap down in price when the stochastics are in the oversold area would be good indicators that a trend is getting near the bottom. If this is all occurring when a moving average is within striking distance, then entering at a price right at that moving average becomes a better-calculated entry point.

Whether this analysis is done after an extended downtrend or after a pull­back after a recent breakthrough of a moving average in uptrend, it provides a logical target for a when a trade should be entered. The more conservative approach is to wait and see if a candlestick “buy” signal is formed after the moving average has been touched and the time-frame has ended. Although the latter approach is more conservative, the candlestick signal analysis will usu­ally put an investor into a trade well before the conventional technical analyst feels the support level has been confirmed.

The combination of visually being able to identify the candlestick signals and understanding which moving averages produces high probability support and resistance levels provides a powerful trading format. Through simple scan techniques, an increased number of highly profitable trade potentials can be found on a constant basis.

Fig. 3-19, The Apartment Investment & Management Co. chart reveals a strong buy signal after the gap up from the Bullish Harami in the beginning of the second week of July. As illustrated, the gap up bullish candle after the Harami demonstrated that there was no resistance at the 50-day moving average as seen one week prior. At that time, the Shooting Star signal just touched the moving average for the first time. The gap up from the Harami was a very strong bullish signal. The up-move remains strong until the first week of Au­gust when the Hanging Man signal was followed by a Doji/Harami. The gap- down the following day was confirmation that the uptrend was over. A pull­back should be occurring.

What would be the target for the pullback? Obviously, the moving aver­ages! In this case, when both the 50-day and the 200-day moving average are close together, either one or both could have been the support level. The Bull­ish Harami confirmed this support and prices gapped up the next day.