How to find the right support and resistance

My personal preference for day-trading and short-term trading is to buy dips and sell rallies.

Two components are needed to make this strategy work. First, you have to be trading in the direction that gives you the best chance of success. Second, you have to be able to identify potential support or resistance for that trading day. I'll discuss one technique from each of these two components that make up my day-trading approach.

The first step is to determine which way the market is likely to go today -- in other words, is the trend up, down or sideways?

One method to determine the market trend involves a couple of old standby technical indicators that are available on virtually any charting software: the Moving Average Convergence Divergence (MACD) and the stochastic indicators. These oldies but goodies really can be useful if used in the proper combination.

Look at both the MACD and the Slow Stochastic on a daily chart to determine in which direction you want to trade the next day. For the MACD, I use a little longer time value for my inputs then the standard -- say, around a 10-30-10 exponential moving average combination. I also use a slow stochastic indicator with an input value of somewhere around 20 days.

Both of these indicators should be displayed together under the price data. Look for situations when both the MACD indicator and the stochastic indicator are on the same side of the signal line.

If both are above their respective signal lines, then trade the buy side. If both are below their respective signal lines, trade the sell side. Quite often you'll find the MACD and the stochastic indicators are on opposite sides of their respective signal lines. In these instances, avoid the market.

The accompanying charts show this simple combination eliminates a lot of noise from the market and identifies those times when the market has the best chance to make a trend move. Throw these indicators up on any chart together, and you will see this combination works infinitely better than either indicator alone.

Once you've determined the direction to trade, the next step is to find support if you want to buy or resistance if you want to sell. There are several ways to do this, and my usual strategy is to employ several methodologies to come up with a confluence or a "keypoint" high-probability trading zone.

Here is one methodology that is being described for the first time. There is no neat name for this indicator, so I'll just call it the 3x5ATR. To construct it:

1. Add up the true ranges for the last five days and divide by five. This is the 5ATR.

2. Calculate a three-day simple moving average of the highs and a three-day simple moving average of the lows.

3. To calculate the 3x5ATR for potential resistance, add the 5ATR to the three-day moving average of the lows. To calculate the 3x5ATR for support, subtract the 5ATR from the three-day average of the highs.

An important point is that this is not a total day-trading buy stock strategy. Look to combine other techniques that identify potential support and resistance points. A good rule to live by is to look for a confluence of support or resistance by integrating analysis techniques and integrating time frames.

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