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Trading Lessons: Recognizing Support and Resistance


Taking the case of FSLR and the S&P 500.

Editor's Note: The following was posted in real time on our premium Buzz & Banter (click for a free trial). It's being shared here for the benefit of the Minyanville community.

On June 16, I discussed
First Solar (FSLR) as a short, when it was at $176.91.

Click to enlarge

As soon as it broke the all-important support levels from lower highs, as shown in the chart above, it displayed extreme weakness and shed 10% in 5 trading days. Yesterday it traded at $161.50, oblivious to the strength displayed by the rest of the market.

Click to enlarge

It had tried to regain the pivot-point it broke down from, but that "bed of arrows" proved to be significant resistance this time.

The best-case target for that short would be around $155, but I'd pay close attention to today's volume -- there could be a washout in the progress, given that -- at only 2 and a half hours into trading on Thusday -- FSLR was already trading at 105% of its daily average volume.

This is why short patterns deserve particular attention. It's not only about profiting on the short side; it's also about not losing money on the long side by initiating long positions when charts indicate otherwise.

In addition, closing one short position doesn't automatically flip it into a good long scenario -- well, maybe in bull markets. But extremely volatile bear markets might not provide the best risk-reward ratio for such flips.

I wanted to elaborate here on the ideas of support and resistance, since they're central to my argument about FSLR.

Usually, we talk about support/resistance in absolute numbers as defined by some key moving average. But the markets have been so volatile over the past few weeks that these numbers have been changing frequently. So, it's better to rely on the concept of moving averages (and switch absolute numbers accordingly).

Let's zoom in on the S&P 500 to probe this further. On June 1, the 200-DMA was at 927 and yesterday it was just around 898. Unless you're reading the charts on a daily basis, this change can lead you to get lost by a few percentage points.

And this is only going to get more pronounced once the averages start factoring in the September/October drop over the next 2 months (assuming the major indexes don't go up dramatically over that time).

Of course, exponential moving averages don't encounter this problem (by definition) and offer somewhat better insight; the only issue is feeling out of sync with media proclamations of the averages finding support at certain levels.

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No positions in stocks mentioned.

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