Here’s how to discover where support comes in when a rally collapses

When markets runs up too fast it becomes difficult to identify where support might come if there’s a big reversal. Everyone gets an urge to catch the falling knife. The problem is that rallies are like building a house, if the foundations are weak, the house can fall down. When we see moves like this it’s important to try and identify the levels where a price may pull up. This is not just imprtant to give us level to trade from, it’s also important in telling us the story of what’s really going on.

To use an example, I’ll use the S&P. Here’s the chart with some levels identified.

S&P daily chart

Here’s how I look for the best support.

First and foremost you’ll see I haven’t drawn in any levels from the top to the first at 2485. That’s because I see nothing there that looks remotely strong enough, so 2485 is where I start.

  1. 2480/85 – A prior top that’s already held as support. Has further support via the 38.2 fib of the 2016 leg up. The only negative is that it was quite a short period for the action there. It was more of a quick stop for a cup of tea than pitching camp for a while. I like to gauge strength by the time a price takes around a level. Short time = a potentially weaker level. Longer time = stronger. What does add to it is the 55 WMA at 2491
  2. 2405/15 – This level is much better on the time frame. It pretty much took 2 months to break, then held for the best part of three months as support. That’s a nice looking level.
  3. 2320 – A support point but it hasn’t really followed a prior area of resistance. The second touch hold may have been aided by the 100 DMA, in which case, that’s null and void now. I’d watch it for signs of support but I’m not overly keen. The 2341 50.0 fib is worth consideration as we’ve seen support around there’s too. It’s not very clean though and the fib is only relevant on the way back down. It shows there was something going on there but it’s not clear so I’m less inclined to trust it outside of the fib reason
  4. 2280 – We can really look at 2250-2280 and again, it’s not very clean looking. It was also over the end of the year so we can see from the size of the bars, it wasn’t very busy, even into the first days of 2017. Areas built on a lack of liquidity and calm tend not to be too trustworthy
  5. 2180 – This is another level that’s nice and long. Prety much 5 months trying to knock through there at the 2200 handle, and then it became support straight after
  6. 2120 – This looks the strongest level of all. The area was resistance for a very long time, and showed good action as support. We did have a blip though and that came around the time of the presedential election, so that event can excuse the lack of technical acknowledgement

All these levels can be traded but I would match my risk with how strong or weak I deem a level. Looking for the good levels can keep you out of trouble and all the short-term volatility. Because the tech is so lacking around the current price, I’ve really not got anything to lean on, so I’m just watching things develop as we go. If I want to remove myself from the danger, I can ignore everything going on and just sit back and see if we get a move to the levels I’ve identified. Yes, I might miss BTFD but more importantly, I might miss losing my arse trying to pick a bottom in very volatile markets.

At the end of the day, volatility can make or break our trading and so far this year we’ve gone from one extreme to another. There is no need to try and be heroic when trading. If things become too volatile, sit back until things calm down. If you do trade, pick your battles and manage your risk. Make it reflective of the conditions. If you need to scratch that itch, reduce your trade size so you don’t get burnt if you’re wrong. This might be a quick blow out, it might be something more but instead of guessing what it is, let the charts do the talking.

Unless there’s definitive news that there’s something awry in markets, I’ll be a BTFD’er down around the 2485 area with a stop under the 38.2 fib, and I’m not interested in anything else. If it doesn’t trade there, then there will be plenty of other trades in other markets to look at until the price shows me something solid to trade from.

Ryan Littlestone

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