Identifying Forex Support and Resistance Zones
There’s an old saying about those who forget history.
I don’t remember it, but it’s good.
You have to pay close attention to one thing on the chart if you trade naked: price. Price is king. Price will tell you all you need to know.
The wonderful thing that all markets have is this: a history. The market will tell you where the sweet spot is on the chart. These sweet spots will be the foundation for everything you do as a naked trader. A sweet spot on the chart is a support and resistance zone. You may be familiar with the concept of support and resistance, however, support and resistance zones are different from what many traders characterize as support and resistance. I will call these support and resistance zones by one word— zones. The eight important characteristics of zones are as follows:
- Zones are an area, not a price point.
- Zones are like fine wine; they get better with age.
- Zones are spots on the chart where price reverses, repeatedly.
- Zones may be extreme highs or lows on the chart.
- Zones are where naked traders find trading opportunities.
- Support and resistance zones rarely need to be modified.
- Line charts help naked traders find zones.
- Zones are often seen by many traders.
You may want to take a closer look at each of these eight characteristics.
It is incredibly important that you understand how to draw zones, why
you should draw zones on your charts, and understand when these zones
become critical for your trading.
ZONES ARE BIG FAT BEER BELLIES
A zone is simply a big fat beer belly. Many traders have misconceptions concerning zones. Traders may be familiar with the concept of support and resistance but unfortunately, many misapply this concept to technical trading. The naked trader understands that zones are an area on the chart. This is a very distinct concept to a support and resistance line. A support and resistance line indicates a specific price on the chart, but zones are something different. Zones are not a specific price. These zones are, instead, an area, a range, or, as I prefer, a beer belly.
Let me explain. I prefer to think of these zones on the chart as if they were beer bellies. Before you disregard this idea, consider what a beer belly is: A beer belly is somewhat firm, maybe somewhat repulsive, and has some predictable characteristics. My friend Jason has a beer belly. He is quite proud of it; he tells me it is quite expensive, as he has paid good money for the wine and beer that have enabled him to grow this belly. If I were to push into Jason’s beer belly with my fist (I would never push into a beer belly without permission, and I suggest you, too, first obtain permission before pushing any beer bellies), eventually I would find resistance. Even if at first I did not find resistance, eventually there would be a point at which the squishy beer belly would stop me from pushing further. This is a critical characteristic, for I know that I may be able to push a little bit into the beer belly, but eventually the beer belly will offer some resistance. Perhaps you may also decide to push into Jason’s beer belly with your fist. You may have a different experience. Perhaps, when you start to push into Jason’s beer belly, you become somewhat unsettled and decide to pull back after only slightly brushing the hair covering his beer belly. This is completely reasonable, and I am sure that many others will have the same reaction. However, the important thing to note here is that you and I are pushing into the same beer belly, Jason’s beer belly, but we find resistance at different spots on the beer belly.
This is a significant feature of zones. Zones are just like beer bellies. Zones are spots on the chart where price has pushed and probed, and then reversed. Naked traders love beer bellies. They love these zones. Naked traders wait for price to reach these zones before initiating a trade. The zone is the sweet spot on the chart for the naked trader. It is absolutely critical that the naked trader identifies the zones on the chart. These zones are the foundation of naked trading.
OLD ZONES, NEW ZONES
The age of zones, and the importance of the age of a zone, is a hotly debated topic among traders. Some traders believe that only those zones that have been established recently are important, and other traders believe that zones that were established long ago are just as important as the newly minted zones. I believe that zones are recycled.
If you take a look at any chart for any currency, you will find historical price levels. What you will notice is that price has a tendency to reverse at the same levels repeatedly. This is a distinguishing trait of zones, and you may use this characteristic to define and discover zones on your currency charts.
Hot Pizza and Zones
When I was a young child, at about six, I used to watch my mother in the kitchen. It was fun. In fact, some of my very first memories are of my mother singing to me in the kitchen. One day, while in the kitchen, I had a terrible accident. On this day my mother was baking pizza, and it smelled delicious. In fact, you may find it hard to believe, but to this day I still love pizza. My mother was busy chopping up the ingredients for the pizza, making the sauce, because she had several pizzas to make. I wandered over to the first pizza. It was still on a hot pan because it had only just been removed from the oven.
Now, my mother had warned me to be wary of the hot pizza pan. I had either forgotten or disregarded her warning, and I decided to grab the pizza pan because the pizza smelled so good. As you may imagine, I completely burned my hand. I still remember it being extremely painful and still have the scars. I learned a lesson that day. I still love pizza, but I am wary of hot pans. It was a valuable lesson I learned, and is something that I think about every time I look at a currency pair on the chart, I think about that pizza day.
Every time I see a chart approaching a zone, I consider that the market may remember the last time it was burnt at that price level, at that zone.
Do Zones = Market Scars?
Take a look at the Figure 4.1. This is the daily chart for the EUR/CAD currency pair. Note that this pair found support at the critical level of 1.4350 back in July and August of 2006 (up arrow). The pair repeatedly found support at this level over many weeks. Then, in September and October of 2006, the pair trades back to this zone and finds resistance on three separate occasions at the 1.4350 level (down arrow).
Now take a look at the next chart, same pair, the EUR/CAD in Figure 4.2. Here the pair has found resistance back up at the 1.4350 level, four years later. The market moves back to this critical 1.4350 level, finds resistance there and promptly falls. The chart has a memory! This is a very clear zone for this currency pair. Do you think that knowing where price may turn around is an advantage for you, as a naked trader?
Perhaps you may be thinking that other markets do not have a memory for zones. Maybe this EUR/CAD example is just an exception rather than the rule. If you are thinking this, please take a few moments to look at a few charts for yourself. Another example in Figure 4.3, this is the USD/CHF daily chart from July 2008. Notice how the market came down and touched the 1.000 zone (arrow) and then rocketed higher.
Over a year later, in 2009 the USD/CHF falls back down to the same 1.0000 level and finds support on three occasions, as you can see in Figure 4.4. The market traded sharply higher after the third touch on the 1.0000 zone. Again, the market has made a critical reversal at a price that has historically served as a turning point. This is what zones are, historical turning points.
Another example is shown in Figure 4.5. This time it is the EUR/USD daily chart. In 2003 this pair topped out at 1.1930, there were several touches on this zone (see three arrows).
Years later the EUR/USD was freefalling from a high of over 1.5100 and the pair eventually found support 3000 pips lower, on a very critical zone (see Figure 4.6). The 1.1930 level served as critical support seven years later. The chart has a memory!
These zones are critical for the naked trader; once price reaches a zone, the naked trader is on alert for a possible trade set-up. Why would the naked trader want to know once price reaches a zone? Because price has repeatedly turned around at these zones! Knowing what a market has done in the past is critical for the naked trader, not because the naked trader assumes the market will turn around again, but because the naked trader is on high alert, and the market may turn around again.
The naked trader does not take trades based on price reaching a zone, the naked trader uses several tools to decide when to take a trade. However, the naked trader will not take a trade unless price has reached a zone. This is the first step (price reaching a zone) for the naked trader, when setting up a trade.