Technical levels and price points are used in nearly all retail trading strategies, often the traders who learn these methods are not given information as to what causes the technical levels used in the strategy to lose its significance in the market.
A technical level losing its significance is important because it can decrease the probability of the market reacting to the level in the future. If the trader doesn’t know what will cause the level in question to lose its significance then he may be setting himself up for unnecessary losses as he wont be able to determine if a level is okay to be traded or should be left alone as it has no relevance anymore.
In today’s article I’m going to give you a rundown of what causes some of the most popular technical levels to decrease in their significance in the market, to begin with we’ll take a look at the two main things which can cause a technical level’s importance to decline and then I’ll go into detail as to why some typical technical levels lose their significance in the market.
The Two Reasons Why A Technical Level Will Lose Its Significance
There are two things which cause a technical level to lose its significance in the market…..
The first is how long the market has been away from the level itself.
After a technical level has been created it’s almost on a countdown as to when it will become of little use in the market. As time passes the market environment changes, the news is different, the market direction may be different and the actions of the traders will also be different.
These changes will not effect all technical levels in the same way, supply and demand zones which the market has not visited in a long time lose their significance mainly because of the bank traders not having any use for them anymore, if a demand zone forms and then 1 year later the market revisits the zone, the banks are unlikely to place any trades at the zone because so much has changed in between the time the zone formed and time the market returns to it.
The second way a technical level can lose its significance is by the market actually testing the level.
Usually the reasons why a test at a level causes its significance to decrease depends on why the level itself has formed in the market. Not all levels are created for the same reasons which means understanding why they become less important can be tough as you have to figure out what has caused the level to form in the first place.
Luckily I can work out why a level has been created, so I’m able to show you why its importance will decline upon the market testing it as I’ll now show you over the rest of this article.
One final point I want to make before I get in to showing you how the levels decrease in their significance, is not all technical levels will become less important when they are tested or as time passes, for some levels such as support and resistance, their relevance stays the same no matter how many times the market returns to the level or how much time passes in between the level forming and the markets return.
Why Do Breakout Zones Lose Their Significance ?
To understand why breakout zones lose their significance in the market we must figure out why they form in the first place.
The premise behind trading breakout zones is when the market returns to the zone, the breakout traders who have been entered into their trades when the breakout occurred, begin closing their trades as the profit they were in from the breakout has decreased to the point where if they don’t close their trade now they’re going to end up coming out with no profit at all.
After the market has returned to the breakout zone once, the breakout traders are no longer in their trades, therefore if the market was to return to this zone again in the future, its unlikely to cause a reaction because the breakout traders have already exited their trades.
Now if we had a situation where a breakout zone had formed and instead of the market returning to the zone a day or two after it formed the price kept moving away from the zone for another week, there’s a high chance there will not be any reaction at all upon the market returning to the zone because the breakout traders will have all closed their trades and made a profit.
The breakout zone above is one such zone which didn’t work out successfully due to the price moving away from the zone.
Soon after the breakout occurred the market stalled slightly and two candlesticks appeared which would have looked bullish to the breakout traders. The first candle has a wick on the bottom which tells us someone was buying, the candle seen after ends up being a bearish pin bar but during its creation this candle would have looked like a bullish engulfing.
When the breakout traders see this they close their trades as they believe the market is about to move higher, since the high of the bearish pin bar comes to being within close proximity to where the breakout traders had entered their short trades, most of the profit the breakout traders were in will have been diminished to such an extent that the breakout traders will become scared of not coming out with any profit at all and thus close their trades, making a tiny profit in the process.
When the market returns to the zone the next day there is no reaction because the breakout traders have already closed their trades, if we didn’t see the bullish price action which took place soon after the breakout occurred then we still would not have seen any reaction to the zone as the breakout traders will have made a bigger profit from the down-move and closed their trades anyway.
What Causes Support And Resistance Levels To Lose Significance In The Market ?
I think the only technical level which doesn’t decrease in its significance no matter how long the market has spent away from it or how many times the price touches the level are support and resistance levels.
The use of support and resistance levels is widespread through the forex world with a massive percentage of trading strategies based off using them. Now although they don’t lose their significance it’s very difficult to find which support and resistance levels are actually important in the market, with the technical levels which do lose their significance we can determine why one level is more important than the other based on how long the price has been away from the level/zone or how many touches the level has received in the market. Since support and resistance levels do not become less significant no matter how long the market stays away from them or how many touches they receive then it’s almost impossible to say which support and resistance level is more likely to cause a reversal than another.
So with support and resistance levels the fact they don’t decrease in significance is actually a hindrance rather than a help, if we had one reason which we could point to which tells us why one resistance level is less important than another resistance level then trading support and resistance level would be much easier and is likely to be far more profitable.
Swing Highs And Lows/ Supply And Demand Zones
To be honest I think I’ve already covered the reasons why swing highs/lows and supply and demand zones lose their significance in my other article “why recent technical levels are more important than old technical levels”, I don’t want to recover old ground so if you would like a full explanation as to why swing highs/lows and supply/demand zones lose their significance I would suggest reading the other article.
Whilst not really a technical level so to speak trendlines are a tool which traders will frequently use in their trading strategies and in their analysis of the market.
The reason why a trendline decreases in significance the more times the market touches it, isn’t because of the trend-line itself becoming weaker or stronger, it’s because of the amount of traders who will see and in turn use the trend-line the more touches the line itself has.
Most trading books state a trendline is said to be similar to support and resistance in the sense that the strength of the trendline will increase each time the trendline itself is touched and the more touches a trendline has the lower the chance of it being broken.
Because the concept of trendlines is based upon this assumption it makes the traders using trendlines in the their trading think the more touches a line has the lower the chance the market has of breaking it.
Really the opposite is true, the more touches a trendline has the higher the chance it has of soon being broken because of the amount of traders who falsely assume the trendline is becoming stronger.
If lots of traders believe trendlines become stronger with more touches then when they see a trendline in the market which has lots of touches they’ll believe trading the trendline is a high probability trade and the trending movement they have drawn the trendline from is likely to continue.
Here’s a trend-line drawn off a retracement on EUR/USD
This trend-line had three touches before it was eventually broken, to a trader who had the trendline above marked on his charts it would have looked like the line was going to hold because of the three touches and the fact that the price respected the trendline on each touch, in other words the price was not able to close beyond the trendline during any time it was touched.
When the market touches the trendline for the 3rd time a lot of traders are likely to have got into long positions because the price managed to break though through the trendline. When the candle ended up closing as a bearish pin bar and the next candle dropped lower, most of the traders who placed long trades will have ended up closing their positions at a loss.
The important thing is now their belief of the trendline holding has increased, they’ve seen the price try to break the trendline and saw how it failed, if its failed then that must mean the trend-line is strong, otherwise why didn’t the price break past the line ?
On the next touch into the line right in the far right hand corner of the chart you can see the candle which touched the trendline was a bearish pin bar, the traders who were caught going long on the 3rd touch now see this as their opportunity to go short as the last pin which touched the trendline worked out successfully. When they go short the price drops a little before breaking the trendline and moving higher, making all the traders who went short lose money and causing a dramatic shift in the traders perception of the market.
Whilst we need to see two touches in order to draw a trendline on our charts be wary when you see a line which has over three touches because it will be at this point when the trendline is becoming obvious to traders in the market, when something becomes obvious it means lots of people will take an interest in it, with trendlines this means large number of traders will start using the trendline either for analysis or for trading decreasing the probability of the trendline holding and increasing the chance the trendline is on the verge of breaking.
For many traders seeing something occur is more important than understanding why it’s occurred, a technical level is no different. Most traders are able to draw a level on their charts but don’t know much about why the level has formed or what actions will cause the level to become less important in the market, if you don’t know which levels are more significant than others it means you will not be able to trade them profitably so with this small guide I hope I’ve given you some insight as to the things which cause a technical level to lose its significance, if you have any questions about this article, leave them in the comment section below.