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Support and resistance: Way to profits?
It’s common knowledge that successful trading is all about buying at a support and selling at a resistance, with appropriate stoplosses. And more often than not, the real challenge is to identify what is a support and what is a resistance. But does identifying the support and the resistance always ensure profits?

TRENDING VS RANGING: Last week, we had given two calls for the Nifty — to go long above 2830 and to go short below 2550. This obviously meant that we expected a stiff resistance at 2830 and a strong support at 2550. So, when the Nifty rallied strongly last Monday, only to find a stonewall at 2830 (the top on Monday was 2832.85) and then collapsed to find the rock of Gibraltar at 2550 (the low on Tuesday was 2570.70), both our calls were vindicated. But what it also meant was that someone going purely by our call missed out on two 200+ point moves on the Nifty. Although it would have ensured that he/she did not make any loses, that’s hardly a consolation. This makes it imperative for us to find out the reasons why we missed out on these moves? And the most logical reason I can think of is that we expected a trending market, while we currently find ourselves in a ranging market. A trending market is one which has a clear trend, while a ranging market gyrates within a range, going nowhere. So, while one should go long above resistances (when the trend is up) and go short below supports (when the trend is down) in a trending market, all one should do in a ranging market is to go long at supports and go short at resistances. For, in a ranging market, more often than not, neither does the support break, nor does the resistance get taken out. And all we can hope for is to skim something out in between the support and the resistance.

THE TRADER’S MATRIX: While it’s very difficult to objectively explain the above logic and differentiate between a trending and ranging market, the adjoining matrix (let’s call it The Trader’s Matrix) tries to simplify matters, irrespective of whether we are in a trend or a range. As is evident, once you know you are in a bear market, you should first sell at a resistance, instead of waiting for the resistance to give way so that you can go long above it.

If one were to draw parallels between this and our last week’s call, once we knew that 2830 is a resistance, we should have first gone for the short trade, with a stop-loss above it and tried to ride it till the support. Had the resistance been taken out, we should have booked losses in the short trade and then thought about going long above it. For, now 2830 would have become a support and as our matrix tells us, in a bear market, one should selectively go long at supports. How should one be selective? Well, that’s what differentiates a great trader from a notso-great one.

THE RANGED WEEK: As is evident in the chart, the Nifty is now stuck in a range of 200-300 points, with a very strong resistance around 2840-2850. Even last week, the Nifty gyrated vigorously within this range, only to end the week with marginal losses. If any one needs further proof of this tough ranging market, all one needs to do is to take a look at the Nifty’s 20 day moving average (DMA). In about a month’s time, the Nifty has had three false breakouts above its 20 DMA (on November 4, November 10 and December 4). The fact that on each of these three occasions, the very next day has seen the Nifty plunge below it — the simplest of its trend indicators — reflects just one thing: that in the absolute near term, the Nifty has NO TREND. However, even within this tight range, bears are proving to be much smarter than bulls. So, while Monday’s losses saw a massive short build-up , reflected by Nifty December futures adding over 13 lakh shares on Monday, Tuesday’s and Wednesday’s marginal losses saw them covering their positions. This is clearly evident by the fact that on Tuesday and Wednesday, Nifty December futures cumulatively shed close to 11 lakh shares in open interest. So, most bears who had jumped in on Monday, actually got out with marginal profits. However, a majority of the bulls, who jumped in during Thursday’s 5% gains (Nifty December futures added over 20 lakh shares on Thursday), chickened out following Friday’s losses (they shed over 11 lakh shares on Friday). That a majority of these would have gotten out with substantial losses is not too difficult to imagine. FRESH TRADE: Having concluded that we are stuck in a range, the trading calls for this week are typically that of a ranging market. Short around the upper end around 2830-2850 and go long at dips around 2550-2600 , with about a 30-point stop loss in each case. In case 2850 or 2550 are taken out, assume we are back in a trend and just follow it, i.e. go long in case of a break-out and go short in case of a break-down .

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http://www.business-standard.com/india/news/volume-expansions-needed-for-breakout/07/00/50754/on

Source:ET,BS

Investor's Guide : ET

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Source: ET, Deadpresident blog