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The Best Trading Tool

|Includes: SPDR Dow Jones Industrial Average ETF (DIA), GLD, QQQ, SLV, SPY, USO, UUP, XLF
Trading Tool

The One Trading Tool I Use on EVERY Chart By Dr. Van Tharp Trading Education Institute

The Best Trading Tool Out There

I don't care what you trade. I don't care how you trade it. But if you're any good at it, then I can be 99.44% certain (does anyone remember Ivory soap commercials?) that you use the most common and most useful technical tools in the universe.

Before you read on, promise yourself that you'll finish the article. Because we're going to talk about the oldest technical tools on the planet - that also happen to be the most powerful. And familiarity, as they say, breeds contempt. But don't underestimate these incredible tools.

Every great trader that I know uses some form of support and resistance. Let's see how they do it and why you should be looking at these numbers for every trade.

Support and Resistance for Everyone

At its simplest, support is a price level where a stock has traded down to, but cannot go below, for a certain period of time. It serves as something of a "floor" for price.

Resistance is the opposite - a price level where a stock has traded up, but cannot exceed for a certain period of time. If support acts like a "floor", then resistance is a price "ceiling".

This chart of QCOM is one of my favorites - it shows these concepts in visual form.

Stock Chart Support Resistance

You can see some key characteristics on this chart. One key way to know that a support or resistance level is strong is that when broken, price really moves quickly from that level. I see this over and over again on charts.

Next, once a resistance level is broken decisively, it often becomes a support level for future price action. The opposite is also true; old support levels turn into resistance zones for subsequent price movement.

Here's similar action seen repeated in a mid-term timeframe in the Silver ETF (SYMBOL: SLV) over and over:

Stock Chart Support Resistance

Why does previous price action matter?

All the top traders I've ever worked with see support and resistance levels as more than just levels or zones on a chart: these support and resistance levels are seen as decisions points. More than that, they are opportunities to profit.

Many trading patterns are based directly on support and resistance levels. Double tops and bottoms, Donchian channels (the Turtle traders' entry tool of choice), 52 -week high breakouts and many others are trading concepts that rely on support and resistance levels as set-up criteria.

In the simplest terms, support and resistance levels are where traders and investors made prior decisions. Resistance zones are where buyers ran out of strength and profit-takers and other sellers won the day. Support levels are where short, mid or long-term value buyers stepped in when the price of an instrument gets stretched too low.

In addition to chart areas where multiple tests have occurred, traders and investors use different types of prices and price tools to determine support and resistance areas - especially to predict where these areas might show up in the future. Here are few examples:

Significant highs and lows. All-time highs and lows are watched by both futures and stock traders. Stock traders pay special attention to 52-week highs and lows. Intraday traders watch yesterday's high and low and weekly highs and lows for clues as to where support and resistance will show up in the future.

Fibonacci, Gann and other retracement calculations. Support and resistance levels are so important that traders use many tools to calculate where these zones are likely to show up in the future. Tools like Fibonacci retracements, Gann lines, Gann fans, etc. are all used to project future levels.

Moving averages. Moving averages are another common tool used by traders to find where support and resistance may exert themselves. 50-day and 200-day moving averages are watched by so many institutions that they have become levels of "self-fulfilling" prophecy, if nothing else. Keeping an eye on these lines is prudent, if only because so many others are watching them as well.

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