How to Project Future Support and Resistance Levels

Predictions Are Like Ripples in the MarketHow to Project Future Support and Resistance Levels

 

Ok, so you know how to predict where price might find natural support or resistance, and you want to know how to project future support or resistance, right?  After all, if you know with a high probability where price might stop and reverse in the future you can be ready, and have a significant advantage over your competition.  Because this is an advanced technique this post is around 1000 words, so please feel free to copy and paste it into Word or to bookmark this page to return to it later.

 

Two Ways, Two Masters

 

Whenever you hear the word “prediction”, chances are there are two market masters you will hear in the same sentence – Ralph (R.N.) Elliott and William (W.D) Gann.  Both traders are from the first half of the 1900s, both had methods of predicting future support and resistance, and I use both of them.

 

Ripples in the Market

 

Ralph Elliott used an ancient numerical system called the Fibonacci Number sequence to make his predictions.  He believed that many things, including the markets, move in cycles related to these numbers.  You may be familiar with the Fibonacci Number sequence (if you’ve read Dan Brown’s “The Davinci Code” you will have encountered it).  It is made by adding the last two numbers in the sequence together to make the next number, starting from 1 – for instance 1,1,2,3,5,8,13,21,34,55,89,144,233,377, and so on.  These numbers are, when you look at them, like looking at ripples on the surface of a pond becoming larger and larger.  They are also used to create Fibonacci percentages.  These percentages are as follows:

 

 

%

23.6

38.2

61.8

(100)

161.8

261.8

 

 

Now, William Gann also believed that the market moves in cycles.  He split his cycle ranges into halves, quarters, thirds and sixths.  I have personally found that the quarters and halves work best, as adding the thirds and sixths creates too much clutter on your chart (especially when using Fibonacci percentages also).  Thus the cycles used by Gann would look like this:

 

%

25

50

75

100

125

150

175

200

225

250

275

300

 

 

So, how do we use these percentages to predict future support and resistance levels?  We do so by looking at the peaks and troughs, and significant highs and lows.  (If you are not familiar with recognising peaks and troughs, click here to learn).  These of course, can be used on any timeframe – significant peaks or troughs on a daily chart, to weekly or monthly chart.  All will work, but of course the larger the timeframe, the stronger the support or resistance.

 

First – Price Retracements

 

But back to predictions.  How do we do it?  Well, from a major trough to a major peak we look at being the start (0%) to the end (100%) of the move.  But once a stock has made a peak, how do we know how far will it fall?  Here is where we use price retracements to find our answer.  So, using Both R.N. Elliott and W.D Gann’s cycles, what were the percentages between 0% and 100%?

 

That’s right – 0, 25, 38.2, 50, 61.8, 75, 100.  So if we overlay these percentages on our chart (using Market Analyst charting software it is easy – and most charting packages will have this feature) we can see where price may stop falling with a high probability.  I put in bold the percentages that are the strongest.  Click the picture to enlarge –

 

Price Retracements - Click to Enlarge

 

As you can see, price in this case stopped at the 61.8% retracement, before continuing on.  Keep in mind, this works on downward movements also – from significant peaks to significant troughs.  And yes, it has worked a treat during 2008.  Try it out.

 

You may ask “which peaks and troughs are significant, and how do I tell?”  Very simply, they all are.  You can use retracements on all peaks.  If you are worried, use the last significant or major trough and then the last peak.  It won’t work every time, but it will have a high probability of working.  You will get a feel for which ones are most significant with practice and back-testing – keep in mind the longer the ranges the stronger the support or resistance.

 

Up Up and Away – Predicting How Long a Trend Will Run

 

So, we know where price may stop retracing with a high probability, but how do we tell how long the next move will be?  Very simple – price extensions!

 

This time, we still use the low trough and high peak of our original move, but this time we use a third part – the next trough.  By measuring the distance from trough to peak, and then projecting that distance (and percentages of it) out from the next major trough, we can tell with a high probability where the new trend may run to.  Click the picture to enlarge –

 Price Extensions - Click to Enlarge

 

As you can see, the trend went all the way to 100% of the previous range before reversing.  Obviously if could have stopped at any of the percentages from 0% to 300% or more, using both Gann and Fibonacci numbers, but the numbers in bold are the highest probability.

 

What to Do Next

 

So, it looks good, doesn’t it?  We can predict the future with a high probability, and that is usually very hard to do – just ask your local weather man.  But don’t take my word for it.  Go and back-test this for yourself.  Do it over 20 stocks, do it over the last 100 years, the more the better.  It will help increase your probability.  And if you don’t have a charting program that can back-test or do retracements / extensions, now is a very good time to go and get one!

 

 

 

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June 11, 2009  Tags:   Posted in: Free Trading Course Lesson Backlog

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