Price action 101: acceptance & rejection

Support & resistance levels are one of the very first things any trader sees when they come into the industry. Everyone understands the basics of price action.

• Resistance is essentially an area above market that price has reached for, before sellers have ‘resisted’ and pushed price back down.
• Support is essentially an area below market that price has reached for, before buyers have ‘supported’ and pushed price back up.

One thing that many traders don’t see is the behaviour around these price levels. It’s tempting to be excessively mechanical, and say something like: “I’ll buy when resistance is broken as that signals further upside ahead”. On some level, that statement may be true, but it lacks depth.

Auction market theory is a fantastically useful framework popularised by Peter Steidlmayer in the ‘80s. He argues that markets are an ongoing two way auction process. Buyers and sellers are constantly bidding and selling against each other to establish ‘fair value’ at a given moment in time.

• When fair value is established, the market is considered balanced.
• When the market trades away from fair value, this is considered an imbalance.

In a balanced market, there’s an approximate consensus of the ‘correct’ price. When the market moves to an imbalanced state, participants are processing new information and deciding if a new consensus price should be established or if price should revert to fair value.

At any prior resistance point, there are likely to be sellers waiting to push the price lower. At any support level, there are likely to be buyers looking to push the price higher. We can think of these as the ‘return to fair value’ traders.

Let’s take a look at a GBPUSD chart to illustrate this process in action. We’ll start off on the hourly time frame to set the scene:

There’s a pretty well defined area in the centre that we’ll label the fair value zone. Every time the market trades below it the buyers step in. When the market tried to push higher, sellers stepped in.

At some point, the definition of fair value changes. Dropping down to the 15 minute chart, let’s see what happens next.

Focus on the smaller blue box, which marks the Asian trading session. Still within the fair value zone. Then London comes online and there’s an early morning rally from the Asian lows.

The auctioneer goes into overdrive as the market pushes above that Asian session high AND above the previous day’s high of 1.32704. Sellers step in to spoil their party: Fair value must be maintained!

Buyers disagree. They buy the tiniest of dips, and the market heads higher again. Sellers barely get a look-in at the next resistance zone of 1.33025.

Is the market establishing a new ‘fair value’?

This is where acceptance and rejection play their part:

Zooming in again, the red circles highlight the areas to watch.

• Sellers attempted to reject the new value around 1.3280. Buyers accepted that higher value.
• The same happens again at 1.33242. Sellers reject higher prices…
• Their selling pressure pushes the market back down to the 1.33025 broken resistance level.
• Once again, buyers step in at 1.33025
• Crucially, buyers then buy the dip again at 1.33242

A new area of ‘fair value’ is established above 1.33396 and the process repeats again before prices head on to the next level:

Key takeaway: How prices behave around key support and resistance levels will often provide clues about the conviction behind the price moves and should factor into a traders decision-making.

Not investment advice. Past performance does not guarantee or predict future performance.