SUPPORT/RESISTANCE CONTINUED

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If we continue with our example of overhead resistance, when price hits resistance the real battle between buyers and short sellers begins.You have two types of traders here. The longs that bought here and are waiting for price to come back to them so they can sell and break even.

Then you have the short sellers who sold here and did not take profits and see their paper profits eaten away and don't want to go negative.So, at resistance it is counter intuitive because you've got sellers who will have to buy to close their short positions and you have buyers who have to sell to break even.

If price closes above resistance on higher volume this signals a valid break through of resistance because that tells you that all the short sellers have gotten out and the breakout was sustained by new buying. If the breakout is on lower volume it cannot be sustained because it is not supported by new buying, and indicates the move was a short covering rally.

In most cases due to buyers selling to break even there will be a bounce off the level even if it does eventually signal a valid breakout later. A valid breakout without a bounce indicates a strong move and a continuation to major resistance is a high probability.

However, a reversal is different from a bounce. A reversal is a three bar pattern which consists of the bar that tests resistance, the bar after the bar that tests resistance, and the bar following that bar.

There are more explicit details in THE LAWS OF CHARTS AND MEN but here are some basics.

If the 3rd bar closes down below the low of the 2nd bar you have a reversal and probability is high that price will go back down to test the prior high which it had broken through to get up to the level of current resistance.That prior high is now minor support on the way back down where the same process repeats itself.

This is the nature of support/resistance reactions. That is why Support and resistance tops and bottoms are often called reaction highs and reaction lows by professionals.The reaction is the psychology and the chart pattern indicates the resolution of the psychology at that particular level.

Jerry
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