It’s always very important to spot important support and resistance levels.
But it is even more important to determine when the market has been rejected from those levels, or better yet, how to spot false breakouts so we don’t get trapped by them.
In this article I will explain the methodology I use to determine:
- When the market has been rejected from an important long term level
- When the market is trading at an important level
- False Breakouts
Before we continue, let me ask you one question: On the chart below, you think the market already broke the 1.6233 level down?
We’ll see the answer later in this article…
Support & Resistance
Studying the best way to draw support and resistance levels is out of the scope of this article, but you can read about it here.
There just a few ideas I want to make clear:
Once the market breaks through an important support level, it becomes an important resistance level, and by the same token, once the market breaks through an important resistance level, it becomes an important support level.
When this happens, there is a shift in the balance between supply and demand.
What was considered “cheap” (the support level kept the market from falling below this zone), becomes “expensive” and the market is likely to get rejected again from this level.
This looks something like this:
Now, why are these levels so important?
When you open your trades around these levels, the market is likely to continue on your favor.
When Long: If we go long near an important support level, the likelihood of our trade increases in our favor (since the market was previously rejected around this zone or level) –bulls outnumbered bears.
When short: if we go short near an important resistance level, the likelihood of our trade increases in our favor (since the market was previously rejected around this zone or level) –bears outnumbered bulls.
The SF Box: The key to spot false breakouts
They key to spot false breakouts is to consider important long term support and resistance as zones (or ranges) instead of plain levels and this is what we call: The SF Box.
You might want to test this, pull up any daily chart and you’ll see that important support and resistance levels are ok even if you move them a few pips up or down.
Therefore, the best way to define long term support and resistance levels is through the SF Box.
Let’s take a look at some charts to clarify this concept.
Let’s go back to the chart we saw at the beginning of the article (daily chart) and I ask you again: Do you think the market already broke through the support level?
Most traders would say yes and would be looking for short opportunities. I’d think twice before looking for shorts….
And you could see why in the short term charts:
In this chart we can see that, it doesn’t really matter whether the market is trading above or below the blue line (long term level).
What really matter is whether the market is trading above or below The SF Box (red zone).
And as long as the market trades in between The SF Box there are many unanswered questions: we don’t know if the market is going to break through this level, rejected from this level, etc. Actually we don’t know anything, we have no information about the future direction of the market (as long as it trades in between The SF Box).
Incorporating The SF Box to your trading plan
Using this concept, we can develop a trading plan like this one:
Valid Breakout – When the market breaks below The SF Box, in this case I’m only going to look for short opportunities.
Valid rejection – When the market breaks above The SF Box, in this case I’m only going to look for long opportunities.
I’ll now that as long as the market trades in between The SF Box, I’m not going to do anything. I’ll just patiently wait.
From now on, when the market approaches an important level, think about The SF Box and make your trading plan.
Now it’s your turn…
What do you think about The SF Box?
Do you use other strategies to spot false breakouts?
Let me know in the comments…
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