Resistance is the price level at which the sell orders have overwhelmed the buy orders, causing rallies to fail. Resistance causes buyers to stumble and to reassess where they think prices are headed. Traders who were long and did not sell at the high point of the rally will be anxious to unload their positions if prices rise back siûty
To view this image, please refer to the print version of this book up to the levels that they missed—causing resistance. Also, sellers who wanted to short the stock or sector when it was higher feel regret for having missed the opportunity and will be waiting to sell at the higher price if it gets back up there. The previous day's high price is short-term resistance for stocks and the broader market.
Sharp market makers use levels of price support and resistance to take the other side of order flow by selling incoming buy orders at areas of price resistance, or buying incoming sell orders at levels of price support. The incoming buy or sell orders that reach the market maker's desk when a move has just about run its course near resistance or support is usually retail-driven. Retail order flow generally comes from nonprofessionals, who normally chase stocks if they missed their ideal entry points, due to a spate of greed or fear.
It is not uncommon for market makers to see orders originate from the same source when a move has just about completed its course. These orders tend to be predictable contrarian indicators because the traders who are entering them are driven by their emotions. Emotion-driven traders have the habit of panicking at the same recurring price patterns.
When market makers take a stand at levels of support or resistance, they use short-term sentiment indicators to confirm that the market may be holding and reversing. They watch fair value to see if the futures are trading at a discount or premium. They watch the tape to see what size prints are hitting the tape: Are they block prints or smaller retail prints? If the market is falling to a level of support, a market maker may test the bids to see what sort of buy interest is out there before going long. It is not uncommon for a market maker to hit the street with anywhere from 5,000 to 25,000 shares, depending on the liquidity of the stock, simply to see if there are any real buyers out there. If the bids fade and no one buys the market maker's stock, then chances are that the support level was not valid. If buyers in the street step up to buy the market maker's stock, then the market maker knows that the support level is valid at least for the short term, and can quickly reverse the position, using the support area as a stop-loss point.
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