Back in 2008 I started speaking about evolving or dynamic support and resistance, both in the Ichimoku Cloud and in using moving averages.  I've been getting a lot of questions from my newer students lately about dynamic support and resistance so thought I would write an article about it here, what it represents and how you can use it in trading.

 

In essence, there really are two types of support and resistance levels (or models);


Static

&

Dynamic

 

Examples of Static Resistance/Support Models

 

Before I get into dynamic support/resistance models, I'd like to explain the more traditional Static models. These are the most common ones people are aware of;

-the horiztonal lines
-fibonacci levels
-pivot points
-trend lines
-channels, etc.  

 

Any type of support and resistance lines that do not change would be considered 'static'.  For example, once you draw a fibonacci level for a move, those fibonacci levels do not change over time.  The 38.2% retracement level of an uptrend from point A to B will always be the 38.2% retracement level.  That is not to say you cannot draw new lines, but the ones you draw will never adjust themselves based on the market. They are what they are.

 

Below is a chart using several types of support and resistance.

 

Exhibit A
 

As you can see in this chart, we see many forms of static support and resistance levels, such as the various pivot levels, the horizontal levels, the fibonaccis, etc.  In fact, you may notice how price respected these levels, particularly at the double top, along with the horiztonal level drawn along the 61.8% fib level, or how the current candle stopped at the daily pivot.

 

You may even further notice how the 61.8% fib also has a horizontal line drawn which acted as both resistance in the past which became support.  This is called becoming a role reversal level, where the role of that level reverses from support to resistance or resistance to support.

 

There is no doubt price action reacted at various key 'static' levels of support and resistance and learning how to spot these will be critical to your trading.  The reason why these work is the big players used their money (and a lot of it) at those key levels.  And since the market and traders have a memory, if they thought a level was significant before, it goes to reason they will again.

 

In most cases, these are the most popular between the two and I understand why.  Its easier for the mind to think in more static or fixed models.  Change requires more flexibility of thought and possibly re-wiring the brain to see things in flux instead fixed lines in the sand.  Just draw the lines properly and you have your levels - clean and neat.

 

But price just doesn't trade in static world.  Price is evolving in real time, breaking out of key support and resistance levels.  Often times making new highs or lows where there is no history because price has never been there.  If you only used static models, what would you do then when there is no historical price action?  You'd be paralyzed because you'd have no levels to work with.

 

This is where dynamic support and resistance levels come in as they evolve with the market in real time. So let me explain what  functions inside the model of dynamic support and resistance levels.

 

Various Types and What I Use Everyday

 

Due to the hundreds of indicators, I will make a small list here how to draw dynamic support and resistance layers.  Some examples are;

-Moving Averages (exponential, simple, etc.)
-Ichimoku Kinko Hyo
-Linear Regression Lines
-Price Channels
 

To name a few.

 

It should be noted these are types of indicators called 'upper chart' indicators, meaning they are in the upper parts of the chart that interact with price action itself because that is what they are based upon.  It is their interaction with price that makes them useful to us as traders and creates trading opportunities. Because they are evolving, dynamic, and interact with price action in consistent ways, this the exact reason they can be used as a type of support and resistance.

 

What I Use Everyday

 

Anyone who has come to my free weekly price action webinars or seen any of my content will know I use the 20ema (exponential moving average) and nothing else when trading price action.  Why?

 

Out of all the MA's (moving averages) I have seen and worked with, price tends to react to the 20ema more than anything else which leads me to believe the larger players are more likely using it than any other EMA. If they weren't, then you would not see price react to it so consistently over time.  You can see this on any time frame, from the 3min, to the 1hr to the dailies.

 

Here are some examples below and then I will discuss what you can read from the 20ema in terms of the market.

 

3min Chart EURGBP
 

1hr Chart EURUSD
 

You can see from the two charts above the various ways price action can and does relate to the 20ema, giving great trading opportunities while representing how dynamic support and resistance works.

 

What It Communicates

 

In a range bound environment, the 20ema will do very little as price is stuck between a floor and a ceiling with already existing support and resistance levels.  However, when the market is trending, this is where it can become highly effective as it communicates a tremendous amount of information, such as;

-Speed of the buying/selling (angle of ascent or descent)
-Volatility (price distance or spread from 20ema)
-Whether the Trend is Over-Extended (also distance from 20ema)
-Whether a reversal is forming (key break of 20ema)
-Locations to Get Back In (pullbacks, rejections and touches off the 20ema)
-Momentum in a Trend
 

So as you can see, the 20ema will communicate a lot to you as a trader offering you valuable information and opportunities to get into the market, especially in trends which is one of the hardest things for traders to take advantage of.  Institutional traders know trends do not go in a straight line and often use the 20ema as an opportunity to get back into the trend at a cheaper price.

 

How I Use It

 

There are many ways I use the 20ema as dynamic support or resistance, but I will share one major way that you can use in everyday trading.  This I call the Trend-Continuation (or Trend-C) method.  This is where I use the 20ema as an opportunity to get back in the trend when the trend has shown it is most likely to continue.  As I said before, you can use this on any time frame, but I prefer to use it on the 1hr, 4hr and dailies (or the 3min/5min for intraday trading).

 

It is important to note a few variables that should be in play before looking to get into a trend, such as;

1) price already has a stable relationship to the 20ema (meaning consistently below it or above it for at least 6+ candles)
2) price has already tested the 20ema once, failed to close above/below it and the trend continued after relating to the 20ema

 

If I have the two variables above in place, then I will look for a Trend-C entry to get back into the trend using the 20ema as my trigger to get back in.

 

An Example

 

This was a trade I recently took and even discussed in my most recent price action webinar. Notice how in the chart below price had a very stable relationship to it with several touches (8 prior) off the 20ema which all resulted in price continuing higher.  Now notice the last bar on the top right of the chart (pinbar) whereby price had its largest pullback in this upmove, landing right on top of the 20ema.

 

Using this clear rejection off price with a nice pinbar setup, I waited for a pullback into the pinbar itself, then took a long with the stop just below the 20ema itself.  If price rejected off the 20ema before, then obviously buyers came in there to get back long on the pair.  As you can see, this is what price did, going right back to the prior swing high point in the chart below.
 

To recap the methodology, I look for price to establish a relationship to the 20ema, by having a clear direction above or below it.  I then look for price to respect the 20ema, either rejecting off of it, or closing right above/below it in the direction of the trend without any closes on the opposite of the 20ema and where price is trending.

 

Once price has developed this relationship to it, I look for a price action trigger, such as a pinbar, outside bar (engulfing bar), piercing pattern, or just a strong rejection off of it.  Then I look to take the pullback to that level, and put the stop on the other side of the 20ema, ideally below the high/low of the candle that pierced the 20ema.  I will then target a major swing point making sure I have a 2:1 reward to risk ratio.

 

If I think the market is going to go for a runner beyond my swing point, I can then trail my stop on the other side of the 20ema to give it room to breathe while consistently locking in profits.

 

This is just some of the ways you can use the 20ema as a dynamic support or resistance level but should give you a better understand of how this type of support/resistance model works and how you can implement it in your trading.  In reality, static support and resistance models are only half the picture and sometimes those levels are clearly going to be broken, so placing your orders there expecting price to stop is not always the best idea.  This is where learning to read the price action, along with using dynamic support and resistance (other half of the picture) will help give you a more complete way to deal with support or resistance.

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