Sentiment in the Forex Market: Indicators and Strategies to Profit from Crowd Behavior and Market Extremes

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The Power of Technical Indicators 105

Some traders thrive in such an environment, but most do not. I know

that my personality is too impulsive to scalp successfully, which is why

I r efrain from making trading decisions based on charts shorter than

hourly bars.

SUPPORT AND RESISTANCE

Before we go any further, it is vital to present the foundation for all of tech-

nical analysis: support and resistance. Support is an area below the mar-

ket price where buying overcomes selling (Figure 6.2). Resistance is an

area above the market price where selling overcomes buying (Figure 6.3).

Support and resistance are estimated in different ways, including previ-

ous highs and lows, Fibonacci retracements and extensions, pivot points,

FIGURE 6.2 An example of round number support for the USDJPY just above

100.00

Source: Chart created on TradeStation

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, the flagship product of TradeStation Tech-

nologies, Inc.

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106 SENTIMENT IN THE FOREX MARKET

FIGURE 6.3 An example of round number resistance for the GBPUSD at 2.0000

Source: Chart created on TradeStation

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

, the flagship product of TradeStation Tech-

nologies, Inc.

moving averages, and sometimes round psychological levels such as

USDJPY 100.00 or GBPUSD 2.0000.

Properly identifying support and resistance is critical to becoming a

successful trader because a big part of market timing depends on buying

close to support and selling close to resistance. Also, support and resis-

tance should be viewed as a zone, not a point. For example, 101.00/102.00

was a long-term support zone for the USDJPY. The 1993 low was at 101.10,

the 1999 low was at 101.26, and the 2005 low was at 101.67. Similarly, the

zone surrounding 2.0000 was resistance for the GBPUSD as the 1991 high

was at 1.9990, the 1992 high was at 2.0035, and the January 2007 was at

1.9914. The pair eventually broke through resistance in the summer of 2007,

which brings up another point about support and resistance. Once support

or resistance is broken, the level in question becomes its opposite. In other

words, former support becomes resistance and former resistance becomes

support. See Figures 6.4 and 6.5 for examples of this.

Understanding not just where but also why specific price levels

act as support or resistance breeds the confidence required to trade

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The Power of Technical Indicators 107

FIGURE 6.4 The 1.2500 level was resistance in July 2004, August 2005, and

September 2005. That same level became support in July and October 2006

Source: Chart created on TradeStation

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, the flagship product of TradeStation Tech-

nologies, Inc.

successfully. Successful traders are confident in their approach because

they understand it.

Support and resistance are so for a reason. These are not just arbitrary

points on a chart. There is a psychology behind why support and resistance

are where they are. Consider the USDCAD chart in Figure 6.5. In November

2004, many traders bought and sold near 1.1700. Those who bought were

delighted with themselves as the USDCAD traded higher over the next sev-

eral months. Those who sold were feeling pain as their losses mounted.

When the price came back to the 1.1700 level in October 2005, the traders

who were long protected their positions by buying more, and the traders

who were short were ecstatic to get out of the trade at breakeven by cov-

ering their shorts. Both groups bought in this instance, and 1.1700 was sup-

port again. However, bearish sentiment ensured that the buying was not

sufficient enough to hold 1.1700. As price, now below 1.1700, trades back

to 1.1700, those long now decide to get out at breakeven and bears returned