(ZT) Why Support And Resistance Work

abracadabra

Most technicians (and many fundamentalists, too...even if they don't admit it) watch for these clues on price charts.  Seeing how stocks react from these squiggly lines are meant to give a clue about future direction, or at least give some context to recent performance.

There is nothing inherent in these, or most other technical indicators, that make them work.  They are simply a reflection of human psychology.  That's why more recent support and resistance levels (and trendlines) tend to work better than old ones - we have short memories.

And the more recent activity is reinforced, the harder it is to break.  Per NYU (via Futurity.org):


While researchers have traditionally seen long-term memory as fixed and resistant, it is now becoming clear that memory is, in fact, dynamic and flexible. As a result, the act of remembering makes the memory vulnerable until it is stored again—a process called reconsolidation.

During this instability period, new information could be incorporated into the old memory. This was the phase during which researchers at New York University sought to employ a technique to block the return of fear memories. They showed that reactivating fear memories in humans allows them to be updated with non-fearful information, a finding that was previously demonstrated in rodents. As a result, fear responses no longer return.

In other words, if you get burned once, it creates a fear memory.  And that will continue to haunt you unless you face the fear quickly thereafter and update it with a better memory.

What's that got to do with trading?  Well, how many times have bulls been quick to sell as the S&P 500 approached 1110 lately?  They got burned by buying into that level in mid-November...and every subsequent time since then.  The "fear memories" have not been replaced with something positive yet.

Perhaps that's why when the fear memory is finally replaced by a breakout, we tend to see a continued move in the newly "safe" direction.

Wolf

ranchgirl

usamonkey