Test, test, test is what the market does. It is through testing that equilibrium is sought. It is at price levels of importance where equilibrium exists the longest. The reason for this is pretty simple: It just so happens that at that particular time and price level both sides of the tape become equally convinced that they are right in their desire to both purchase and sell. Being able to pick those price levels out before
they occur is a significant advantage.
Although nothing in the market can be done with certainty, there is a way to increase your odds significantly. To illustrate that point, I’ll use the Nasdaq 100
(^NDX) proxy, PowerShares QQQ
(QQQ) because it just so happens we are at one of those points where the odds of a reversal have increased significantly.
The chart below is annotated to illustrate the concept of an anchored resistance zone. This is probably not a term you have heard before but the idea is reasonably simple. Anchored resistance (and support zones) come into existence as a result of congruency or overlaps in anchor bars.
(Charts courtesy of investools.com.)
Anchor bars come in three flavors; bars that have wide price spread and/or high volume relative to all other bars on the chart and bars that are prior swing point highs (or SPH) or lows (or SPL). Take a minute to look at the chart and you can see that each circled bar is an anchor bar and that the overlap between them creates the anchored resistance zone.
An anchored resistance zone is much more powerful than a resistance line.
First of all, it’s a price zone rather than a line so it provides a range where price should turn which is much more realistic. Secondly it is the result of an area of the chart that showed prior significance. Equilibrium happens at areas of prior significance; it doesn’t just magically happen in the middle of nowhere. Traders and investors don’t decide that a particular price area is both a buy and a sell unless there is something significant about it.
Now with most things technical, it helps when there are other supporting factors and in the case of the QQQs currently, there are two other technical patterns that have import. The second factor is one that most of you are familiar with and that is an unconfirmed AB=CD pattern higher.
I use the term unconfirmed to suggest that it has a higher probability of failing prior to reaching the 1:1 extension that is normally associated with AB=CD patterns because volume when crossing the B point on the way to making the D point was lighter and my research shows that the probability of the pattern failing or falling short increases in such situations.
This notion of volume is interwoven into the third point as well and that is that in the case of the QQQ, the same break of the B point also happened to be a break of a prior swing point high (or SPH) as shown below.
I have written extensively about the idea of suspect versus confirmed trends in both articles and in my books but suffice it to say (for now), that the probability of trend continuance on the break of a swing point when volume is suspect is less than if it is confirmed.
So, when I look at this chart and consider that the trend is suspect, that the AB=CD pattern is almost complete and that price appears to have stagnated at the anchored resistance zone, it tells me that the probability of a retrace is quite high. The next question you have to ask from a trading standpoint is what might that retrace look like. In other words, is there enough room to try and trade it?
To make that determination, what you need to do is to turnaround and look at the closest anchored support zone which, in this case, is about 1.5% to 3% back from yesterday’s closing level as shown here.
Thus, depending on your time frame and how your portfolio is position, this might be worth trading or it might not -- that really depends on you and what you are attempting to accomplish. Just realize that the probability that a retrace occurs is reasonably high and the likely minimum price area it is heading for is defined by the support zone above. It is there where one has to expect that equilibrium should surface again but we won’t know that until it gets there!
If price comes back to anchored support and equilibrium takes hold, then that would be it for the retrace and it would be time to think about adding to the long side again. If it doesn’t then the retrace could be deeper.
The critical point is that although we can read the chart to see where anchored support and resistance is, whether equilibrium materializes at those levels we won’t know until we get there. It is when the test area is reached that we can assess how the test proceeds and use that knowledge to assess the probability of which side appears more likely to win that battle. You naturally can and will have an expectation about anchored resistance and support levels.
I am reasonably certain that we will get a quick but shallow pullback here with the anchored support as outlined probably holding. Fortunately, I don’t have to trade the anchored support part of the trade now but can instead wait to evaluate when reached.
It is in this way that a trader can profit. Understanding where price equilibrium is likely to occur enables you to make your move slightly prior to the herd and it is in this way that you can kick up the dust rather than eat it in this cattle drive we call the market.
No positions in stocks mentioned.