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Reviewing the concept of Support, since we just broke it.

February 27, 2009 Equity Trading No Comments

Since the S&P just broke the 741 Support level (established November of last year), now is as good a time as any to say This is BAD!

According to John Murphy:

If the support level is violated, then a trend reversal from up to down is likely… As a benchmark, some chartists use a 3% penetration as a criteria for major support and resistance levels [to reverse roles]. Shorter term support and resistance areas would probably require a much smaller number, like 1%…It’s important to remember, however, that support and resistance areas only reverse roles when the market moves far enough away to convince the market participants that they have made a mistake. The farther away the market moves, the more convnced they become.

From Investopedia:

Traders should avoid placing orders at these major points, as the area around them is usually marked by a lot of volatility. If you feel confident about making a trade near a support or resistance level, it is important that you follow this simple rule: do not place orders directly at the support or resistance level. This is because in many cases, the price never actually reaches the whole number, but flirts with it instead. So if you’re bullish on a stock that is moving toward an important support level, do not place the trade at the support level. Instead, place it above the support level, but within a few points. On the other hand, if you are placing stops or short selling, set up your trade price at or below the level of support. ¬†

Sources:
Investopedia on Support and Resistance

For those looking for a good book on Technical Analysis, I highly recommend Technical Analysis of the Financial Markets by John J. Murphy. Almost every serious trader has read this book.
If free is your thing, you can read it online using google (link).

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