Resistance is equally powerful on the short side. If you approach a resistance line and reverse, the market will typically sell off at the reversal, and you will have a nice big drop that can be shorted. Conversely, if you break through a resistance level, as we saw in our first example, then the chart is most likely going to make a strong move in the positive direction.

Again, the reason this happens is because the market is watching that line. As price goes through the line, people pile on their buy orders because they think the stock is going higher. It is a self-fulfilling prophecy. All of these patterns work the same way. They are all based on the psychology of the market seeing the pattern and reacting to it, thereby accelerating the pattern formation.

Support & Resistance Reversal

Here is our expanded structure diagram for Support and Resistance. The reason we have two Eighths tools is that you can have a bounce or a break. The more powerful of the two is going to be a break. Support breaks do create panic, and you really want to watch for those. But, equally tradeable is a support bounce. Again, you are looking for the third bounce. Typically you will see where the chart bounced off a price level and now it is coming down for the third time. It is that third bounce that is typically the most tradeable. But, you can trade the second bounce as well.

Looking at our structure, you can see that the target is drawn at the 50% level on both the upside and the downside, which gives us our 3:1 Reward:Risk from the ideal entry point.

We just do not know how much it is going to move. We draw our Eights scale across the prior move. If I look on this chart -- this is very subjective -- I would say that relative to the size of the prior movement, that setting your Eights scale towards the lower support at $15 would be a good starting range. Remember that the placement of the Eights scale is not critical; However, it is better if you place one that is closer to the dimensionality of the chart.

Using the scale that I chose, from $18 to $15, you can follow the move all the way down from the hypothetical short trade at $17.40. You can see that I did not close below an Eights scale line and go back up across the prior to the end throughout our Eights scale. In cases like this I like to draw another Eights scale as an extension.

What the Eights tool is doing in this chart is it is keeping me in the trade through several places in the chart where it is bouncing up and down. Again, you have to look at where the price bars close. You have to wait for the close of the day and look at the closing price. If they close below the line, in this example because we are going short, then I move my stop down to the prior Eights scale line. If you look at the end of January into February, we did not close just below the $13 level so that is why we did not get taken out near the cross of the $13.75. The market did not close through there until we actually broke down and starting moving lower.

The Eights tool will keep you in trade much better than any other trailing stop. It does this because you are matching the stop values to the dimensionality of the chart.

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