When talking about Support and Resistance Levels, or S/R Levels as they're also called, if I were to tell you that my analysis has 1st long term horizontal support on the Dow Jones Industrial Average between 14,198 and 14,221 - a narrow 21 point zone just below the round number of 14,250 - what kind of credence would you give that? If I were to continue by saying that there is more minor LT support approximately 900 points below that level, what would you think? And if I were to continue by saying that the next significant support below that is the 12,471 to 12,518 area, and that 1st IMPORTANT SUPPORT lay at 11,750, would you still be reading, or would you have closed the web page by now?
If you're an independent thinker, the odds are good that you would have closed the web page.
How about I give you a chart with all that laid out with some basic annotations and explanations? Would that make a difference? If you're like me, the answer is yes.
Okay, let's start with a long term term chart first, and then come back to the shorter term time frame a little later.
How's that for a picture being worth a thousand words? What I've labeled as "Important Support" and "Major Support" immediately jump out at you, don't they? The chart itself has some very explicit annotations that need not be repeated here, but I would like to highlight how I've come up with those levels, starting with the "Major Support" zone.
What I have labeled as "Major Support" is principally comprised of several important consolidations zones, the first three from 1999 to 2001 marking the 11,000 upper boundary, and four more between 2005 and 2012 marking the 10,750 secondary upper limit that originated with the spike highs in 2002 and early 2004. The four consolidations between 2005 and 2012 further cemented the 10,750 level as bulls and bears battled around it, first as resistance, then as support, and then in the 2009 cyclical bull, once again, first as resistance, and then as support. It's that kind of confirmatory price action around a particular level that defines its importance as an S/R zone. The larger the range of the consolidations, the longer they take to complete, and the greater the trading activity within them, the more important they become. The Volume By Price readings completely confirm the zone from approximately 10,125 to 11,000 as Major Support by showing elevated trading interest within those consolidation areas as the bulls and bears battled around the key boundaries. The panic selling on several lower boundary breakdowns further demonstrates and validates the significance of this support zone. Finally, don't overlook the fact that the current 50% retrace (if the recent high or something similar holds) is right on top of that zone! That zone now marks the halfway point from lows to highs!
Moving on to what I view as being the second most important support zone on the Dow, that narrow green band that originates off the 2000 and May 2006 spike highs and the January 2008 spike low takes on even greater importance when considering how price has behaved around that level either spiking, consolidating, or ripping through and backtesting (in both directions). 11,750 is an important S/R level, and you don't have to take my word for it now that you know the basics on what to look for and how to define support and resistance.
The higher price moves away from previous long term structures and the less price history we have, the more tenuous the support/resistance levels become. The blue zone, marked by a roughly 12,500 upper limit, is built around a couple of key bullish reversals and the higher realms of a consolidation zone, but not much else. Moving still higher, I would give 13,250, with its two "smallish" consolidation zones (one with its lows and the other with its highs marking the level) perhaps the same weighting as the 2007 price high level, but I would still consider both of them to be tentative.
Having come back now to those shorter term levels I mentioned at the beginning of this article, I present you with the following "close up" view.
The long term chart in combination with its close up counterpart allow you to see how those levels mentioned in the first paragraph of this article are derived - from the 2007 price high level, to the 2007 and 2012 consolidations, to the Aug. 2007 spike low level, to the green band level in the 11,750 area originating with the 2000 spike high. There's also an extended Fibonacci draw from the May 2011 high to the recent high that gives us a nice 50% retrace right at the 1st horizontal support level that also lines up with the top of the very long term secular channeling I showed you in my last article here on SafeHaven titled Let's Talk Trends, all of with create a confluence of support at ~14,250 that makes that level worth watching closely.
It's obvious from this analysis that some levels clearly have been demonstrated by price action to be more important than others when seen in historical perspective. Nevertheless, and in spite of the importance of S/R - there are even people who trade exclusively on S/R - as with everything TA, there is nothing magic that will guarantee that any of these levels continue to provide support on the way down, or resistance on the way back up should that be the case. The best we can do is to be aware of their existence and compare their relative importance. As always, we need to know what the possibilities are, and in this case that means knowing our levels and their relative importance, and then, as we move back to our shorter term trading time frames, watch what price does as it comes into them and be ready to act accordingly.
(For those who would like to see some more examples of what things look like on other indices and instruments, my Chart Jamboree post from a couple of weeks ago placed special emphasis on horizontal S/R within a more generalized look at market structure and might be of interest.)
Related Study Materials:
http://en.wikipedia.org/wiki/Support_and_resistance
http://www.investopedia.com/articles/technical/061801.asp
http://stockcharts.com/school/doku.php?id=chart_school:chart_analysis:support_and_resistan
http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:volume_by_price
