Often I receive emails with questions about the articles. For today, I thought I would share some recurring questions and answers with you for your benefit. Just a note before we begin: My email has been down for three days so if you have sent an email during that time, I didn’t receive it. Please resend as it is working fine now.
The questions and answers for today all have to do with supply (resistance) and demand (support). We will use a chart of the DOW today to help illustrate the Q&A as this has been a demand setup people have been asking about.
Some of our more astute supply and demand Online Trading Academy graduates have been sending emails about this daily chart of the DOW over the past few weeks. They were pointing out that there was a demand level that offered a low risk buying opportunity for the more active day/swing trader. For those who emailed about this setup, nice job. As you can see above, once price moved above the cluster of trading activity, that area became a significant demand level for a couple of nice trades to the long side. Consider that the only thing that can cause price to move above that area is the fact that demand for DOW stocks exceeded supply at that price level, a supply and demand imbalance. Once price declined back into that area, we know we have a seller selling at a price level where demand exceeds supply. This is the novice seller we want to buy from. Below are some questions that come up frequently. Here are some answers that will hopefully not only help you but also provoke more thought and questions if needed.
Question: Hi Sam: I’ve recently come across your site and have read many of your articles which I find to be very good. I’ve been trading for about 10 years, unfortunately, not as consistent as I would like. I find your support and resistance information to be great. I wanted to ask you a question about some of the charts you have posted when talking about this. At the areas on the charts where you have indicated there to be support/resistance, the lines drawn in sometimes appear to go right in the middle of the bar; in other words, it doesn’t look like it’s at a high or low within that particular cluster. Where or how do you determine where you draw your support/resistance lines? Are you sometimes using opens or closes?
Answer: It is a good idea to make sure that the vast majority of trading is between your two lines. While it would be easy for me to say “include wicks” or “not”, the truth is that each time you change the time frame, some wicks become bodies and some bodies become wicks. Take a look at that area on two different time frames to determine where the majority of trading is and draw your lines there. Using the highs and lows of the candles are fine but often that makes for a very large stop which is not ideal. In the example above, I have drawn the lines around the entire price action as this is how one successful student drew the lines when they sent the chart to me. This is fine as well. While you would have a larger stop drawing lines like this, you would simply reduce your position size to keep your risk within your maximum risk parameters.
Question: Hi Sam, your articles in Online Trading Academy are not only illuminating but also contain gems of trading truths. I hope you could add to my understanding. You have noted that true demand and supply levels are found in “bases, pivots and gaps”. How do you actually quantify demand and supply levels? Very often, these demand/supply levels denote a price range (say 15.20 to 15.50). How do we know at which price within this range should we buy or sell? You have given clues like a momentum bar followed by a reversal bar, slow stochastic crossing and the incision of the +/-100 CCI line. Are there any other specific criteria?
Answer: Thanks for the kind words. While I talk about supply and demand all the time, I certainly didn’t invent it and don’t claim to own any of it. I am actually just repeating the things Adam Smith said a few hundred years ago and showing you what that looks like on a price chart. I am also repeating what Issac Newton said when he spoke of his three laws of motion. The governing dynamic behind trading is not a bit different. The “mass” as Newton would say is the order flow in markets. Were these really Newton’s laws of motion or had they been here all along? Were Smith and Newton really saying anything different at all? I would argue that they were saying the exact same thing with regard to how and why prices move in markets and the laws of motion. It’s the SAME equation and it has not changed one bit today. These two were great minds and I am a big fan; too bad they didn’t have charts like we do today, they would have been great traders.
Back to the question: Trying to pick exact turning points can be a challenge that will not add much profit to your trading even if you’re able to do it. Instead, it’s a good idea to use two lines as I have on the chart above to identify your supply (resistance) and demand (support) levels. This way, you don’t care exactly where prices turn, you’re just betting that they will turn in that area. Above, you would buy once price reached the upper demand line (circled areas) and once that order is filled, you would put your protective sell stop just below the bottom demand line. Again, use a position size that ensures you are not risking more than you are comfortable with.
Other specific criteria that you mention in your email can be in the form of anything you want. A momentum candle followed by a reversal candle AT a demand or supply level is a good entry signal. A CCI overbought or oversold reading AT a demand or supply level is a good entry signal. In other words, you can use any signal you like, just make sure you’re using it at a price level where demand likely exceeds supply or vise versa. We spend tons of time on this in the Professional Trader classes.
Question: I found your description of support, resistance and time to be very interesting and I eagerly look forward to your articles. However, it is my understanding that prices are manipulated by Market Makers and Specialists and often the price does not reflect true supply and demand. Stocks are often purchased by MM to drive prices higher–then the public steps in and prices move even higher. At some point, the MM sells. This can’t be a reflection of supply and demand but only manipulation. Is this right? Your insight would be appreciated.
Answer: Good question. I go over this in class all the time as I spent years on a trading floor watching this very event happen all the time. I handled order flow and if I saw that there was a large amount of supply at a price level and current price was below that, institutions would bid the price up to that supply level, inviting the public in to buy, buy, buy, creating the illusion that price was going to the moon. As soon as price hit that supply level however, the institution often dumped a huge sell order on the market, catching the public on the wrong side of the trade and price would collapse. Welcome to trading J. When you compete at anything, you must understand how the game is played. Those that understand best will get paid from those who understand least. In trading, most people derive their education from books written by people who write books but don’t really trade. As a trader, you will learn to love that. While I am not a big fan of middle men or market makers, I don’t blame them. If you are a market maker, your goal is to price things so you make money, not the person on the other side of your trade. The one place a market maker or institution can’t hide is the price chart which is why that is always where our focus is. Instead of looking at candles on a screen as red and green signals, start looking at them for what they represent, they are the footprints and TRUE intentions of buyers and sellers.
Keep sending those emails and we can address more here in the coming weeks when needed.
Have a great day.
– Sam Seiden, email@example.com