June 22nd, 2010

Buy at Support or On Cross of Resistance?

Clearly, everyone seeks greater certainty about something that by its very nature is unknowable …. the future. We all look to protect our capital by reducing investment risk and continually look for clues, signs and signals that divine what the future holds. Through trial and error, or by what we’ve read or heard from others, we settle on trading rules we believe offer the best chances for achieving this goal.

I frequently and somewhat heatedly discussed (if you’re still here, Marc, hope you’ve had good fortune in this crazy market) one such trading rule: whether to buy a stock at what appeared to be a support area or, instead, on breaks above what you believed were resistance areas. The former approach assumes that the odds were better that a trend would reverse at support than were the odds that a trend would continue and, often, accelerate as it passed through resistance. Of course, both assume a correct read of past price action as to where these resistance and support zones will be. That’s often reduced down to the simple, subjective and often erroneous concept of a trend line.

I’ve always followed the breakout approach encapsulated in the slogan “buy high and sell higher”. I had come to believe that a resistance area was where bears continually overwhelmed bulls in their struggle for control until, finally, bulls succeeded wresting control, finally hold on to it and moving the stock until bears regained their strength for a new fight at some higher level.

The alternative approach argument is that buying at support offers a jump start in that bear/bull battle under the banner “buy low and sell high”. It’s not clear whether having bought at support, the advocate would then sell should the stock ultimately reach a resistance level. What I was sure of was that a failure at support flew in the face of my desire and need to “preserve capital” while failure of a break above always had the fall back position of another quite attempt at crossing over the resistance or, at worst case, relying on the support holding.

To test the other side (“buy at support”), I initiated the following trade today (click on images to enlarge):

On the other hand, I had hoped that PCX, which I unfortunately did not sell all of, might also bounce off its support; so far today that doesn’t to be working:

What say you?

  • Which do you believe is the most conservative?
  • Which the most aggressive?
  • Which has the highest probability of success?
  • Which has the lowest riskof loss?
  • Neither?
  • Both?
  • Doesn’t matter?
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  • Anonymous

    My tech prediction is still a hold on TBT (unless it breaks 37) and TLT (conversely if TLT breaks 100). The pattern formation is the same- one bearish the other bullish if it moves slightly from here. PCX technically just turned bearish at 13.5, but I wouldn't put a trade on it knowing China's cont'd demand and natgas increasing. I would wait on all three at this point. Now, the SP500 returned bullish at 1110 on a tremendous triple top formation (statistically correct 87%). It has a slight pullback from this level but it needed it after a runup from 1050 to 1130. My tech pattern PO is about 1295. The statistics indicate higher levels, nitwithstanding (sic) the big wall-of-worry. But that's what makes a bull run run. Maintain discipline and the statistics will take care of the wins and losses. There will be losers, but the winners will overwhelm.

  • Joe

    Thank you for your input.

  • Anonymous

    GURU,,October 20–21 1987,,October 18–19 1990,,October 14–15 1998,,October 10–11 2002,,,March 10–11 2009,,,Maybe I will wait until October ___2010 ,,maybe 2 big up days with large volume ?? Then Buy hand over fist …

  • Anonymous

    PCX – nice buy signal Joe, for Monday morning, with a very tight stop loss however. But Monday's rally could be BEAUTIFUL for PCX!

  • Craig

    I think that buying at support is better than a cross of resistance. And, here's why..

    When you buy at support, then the price has to have come down to that support level. This means that many sellers have sold BEFORE you buy the stock.

    This is good. You don't want and avalanche of selling to occur right after you have entered!

    If you buy after a cross of resistance, then you are likely buying after price has already moved up. So, you are HOPING that they will continue to buy and you are HOPING that you can get out before the selling starts.

    That is just too much hoping for me!

    Anyway, that is my thinking.

    Love reading your blog!

  • Ryan

    Joe,

    new to your blog but like your style.

    As for the question of what i believe when it comes to "buying support, selling resistance" i would have to say its a false dichotomy. buying alleged support levels in 2008 wouldve got you killed (im sure it blew a few traders out). likewise, selling resistance levels in 2009 wouldve equally blown traders out. So without proper context, both are horrible theories on what to do in the market.

    in addition to this, we've all seen support levels taken out, only to create a divergence and rip higher. in short, i believe if the market has been in a range, it becomes MUCH better to buy breakouts above resistance than if the market had not previously been in a range. We must first ask what type of environment we are in, before we can decide which course of action is correct.