Support and resistance can be seen as the entire basis of technical analysis. While most technicians would distinguish between these two levels based on expected buying or selling pressure, T3Live’s Sean Hendelman sees them quite differently as a high frequency trading practitioner:

“Support and resistance are one in the same. Namely, points of increased volatility. These areas increase the uncertainty of future direction and therefore volatility.”

Short-term Support in the Past

Traders have long used support levels as areas where they expect buyers to step in and hold because there were buyers at that level previously. Price levels exist because people, consciously and unconsciously, create them. Traders and investors remember their entry prices, or at least they see the cost basis on their brokerage statement. These prices are therefore breakeven levels for many with a vested interest in that price.

Often, by expecting others to be buyers at the level, technicians only work to further solidify the existance of support through their own buying. The idea of a vested interest is also why breaking a support level is seen as a sell signal. Those that accumulated expecting the level to hold ditch their positions and eager shorts enter believing no buyers remain.

Support in the High Frequency Trading World

Support and resistance have become far more elusive and the risk of entering trades based on them has drastically increased in the last 18 months. Short-term technical levels are now extremely fluid.

Volatility increases opportunity and the wild oscillations around technical levels grant HFTs the ability to profit by beating manual traders in and out. Consider the 2008 crash with the VIX reaching a high of 89%: short-term traders were offered incredible opportunities as volatility soared. Think of a large whole number in AIG as a microcosm of this type of uncertainty and volatility. The high frequency trader jumping in and out in microseconds, even nanoseconds, can scalp pennies back and forth.

Two unprofitable scenarios now occur much more often at support levels with the influence of HFT: 1) rapid breakdowns and 2) false breakdowns.

A trader does not risk to a level, he risks to whatever price he receives upon exit when the level breaks. As high frequency traders are typically first to the trade in the downdraft when a support level breaks, the price to exit is often much further away than anticipated. By the time he has hit the bid, the manual trader has lost far more than his pre-determined stop.

False breakdowns occur when a support level is broken but the stock does not continue lower, at least not within the trader’s timeframe. How often does today’s discretionary trader short the low only to find the stock subsequently swept higher? High frequency traders will buy new lows and force weak hands to cover as the stocks pushes back through the short price.

The high frequency trading world has very different interpretation of support and resistance and given their speed, it is tough to compete in that world.

Adapting Trading Strategies

Running stops is as old as trading itself. Floor traders on the NYSE used to run stops intentionally for bucket shop owners so the shoe string margin players would be wiped out. Squeezing out larger, weaker players is a tactic used since the day Wall Street was paved. High frequency traders’ manipulations around technical levels are just today’s modern application of an age-old strategy to beat others at the same game.

Short-term traders had it easy for a long time, buying breakouts and shorting breakdowns to make predictable profits. But this strategy in a more range-bound tape coupled with high frequency traders can be disastrous. Avoid the temptation, don’t battle the machines. Let the machines kill each other and don’t step in the ring.

Traders must anticipate moves to much greater degree and they must be happy with the size they have accumulated once the trade gets under way. Adding through levels can and will destroy many potentially profitable trades as HFT throws the trader in for a spin.

Charlie Gasperino over at Fox Business is reporting that Wall Street giant Morgan Stanley (NYSE: MS) has burped up another 200 employees as the winning financial services firm continues to digest brokerage Smith Barney — which it bought from Citigroup (NYSE: C) in 2009.

When the firms are fully integrated next year, the combined brokerage unit, with 18,000 financial advisers, will be Wall Street largest ahead of the 15,000 at Bank of America Merrill Lynch (NYSE: BAC).

Natural selection continues on Wall Street.

JEF

Our partners FusionIQ state: “Jeffries (NYSE: JEF) may be the next brokerage firm to struggle.  After scoring a major top (orange dotted semi-circle) shares then broke what had been longstanding support (double red lines).  Once broken this support became a big resistance zone which shares then subsequently failed at on its recent snap back rally.  Of a more critical note is the fact that JEF shares are tesitng a longer term trend line (green line) for the third time in a relatively short period of time.  The high frequency of trend line tests in such a short period of time suggest that a likely trend break is coming soon.  A close below $ 14.00 would be a crucial breakdown and suggest a move to the $ 10.00 to $ 9.00 region.
Raising the odds we are right here is the fact that JEF shares have a low FusionIQ Master Rank Score of just 41 (out of a possible 100).” To learn how you can get an edge trading/investing with FusionIQ’s powerful platform, click here to watch my product review and take advantage of our special Wall St. Cheat Sheet 20% discount.

ERX

Precision Capital Management submits some more technical analysis candy: “We have posted Anchored VWAP charts here before, but that is only a part of Paul Levine’s MIDAS Method.  The other part is the Topfinder/Bottomfinder (TBF) curve.  When price pulls away from VWAP, a TBF curve is fitted to the first pullback.  Because of the symmetrical relationship between the accumulation and distribution volume of a strong trend, the TBF curve will often predict when the fuel of a rally is consumed.  Above shows a recent TBF curve for Energy Bull 3x ETF (NYSE: ERX), which began October 5 and ended October 21, 2009, which amply demonstrates what happens when the fuel runs dry.  We are doing some exciting research to take MIDAS a step further and will regularly update our readers (free registration).  Also, we encourage you to visit the new website of MIDAS experts David Hawkins and Andrew Coles, who recently wrote a three part series of articles in Technical Analysis of Stocks & Commodities, and who are doing some exciting new research of their own.” (Source: Precision Capital Management)

Corey Rosenbloom, the Technical Analysis Professor, submits: Wynn Resorts (Nasdaq: WYNN) has come into a “Make or Break” support zone at the $60 per share level.  Let’s take a look at its daily chart and note Fibonacci, Moving Average, and Bollinger Band support coming together just beneath price right now. (Source: Afraid to Trade)

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