Candlesticks, Fibonacci, and Chart Pattern Trading Tools : a synergistic Strategy to Enhance Profits and Reduce Risk

Support and Resistance Lines Identifying Trend Changes
In addition to projecting price targets as shown on the S&P 500 Index,
it is interesting to analyze how important support and resistance lines
are as trading tools and whether they give enough information to iden-
tify trend reversals in selected products.
To explain what we are looking for, we start with some graphs
that explain the concept, which is based on the notion that markets ro-
tate (see Figure 6.20). The typical pattern is that support lines become
resistance lines and resistance lines become support lines.
Figure 6.20
Basic support/resistance patterns.
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SUPPORT AND RESISTANCE LINES
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In our analysis, we refer back to the very beginning of the book,
where we explained why we are looking for the magic number three in
our analysis of trend changes.
The four little graphics with basic support and resistance pat-
terns in Figure 6.20 have the following meanings:
• We only look for support or resistance lines that are horizontal
connections of peaks and valleys.
• A peak is valid if it has lower highs on either side of the highest
high; a valley is valid if we f ind higher lows on either side of the
lowest low.
• For a long trend change (see top left graph in Figure 6.20), we
f irst need a valley and a peak to determine the trend line. We
then need a second peak above the trend line to be broken to con-
f irm the trend change.
• For a short trend change (see top right graph in Figure 6.20), we
f irst need a peak and a valley to determine the trend line. We
then need a second valley below the trend line to be broken to
conf irm the trend change.
• For a trend reversal to the downside (see bottom left graph in
Figure 6.20), three valleys touching the support line need to be
broken.
• For a trend change to the upside (see bottom right graph in
Figure 6.20), three peaks touching the resistance line need to be
broken.
Figures 6.21 to 6.23 provide chart examples of the S&P 500
Index, the Nasdaq 100 Index, and the Dax 30 Index. All three charts
contain support and resistance lines drawn according to the principles
previously described. These support and resistance lines def ine prof-
itable market entries at major turning points.
Combining support and resistance lines with Fibonacci ex-
tensions to identify price clusters is safer than working only with
Fibonacci ratios.
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