Support and resistance play an important role in the analysis and understanding of chart patterns in different financial markets. The ability to recognize these levels allows retail traders to make better trading decisions, lower their risk, and possibly achieve better rewards by knowing where to enter and exit trades. Discover how to use support and resistance to your advantage!
Support and resistance are perhaps the most important and actionable concepts in technical analysis.
Neglecting to analyze Support and Resistance Levels is like navigating through a storm without a compass – a recipe for disaster in trading!
What is a Support level?
Support is like a safety net in the market’s chart. It’s a level that the price bounces off when the market is in a bear trend. You know when an asset is falling but eventually it hits a point where it won’t drop any further? That’s the support level. It’s like a price barrier where buyers step in and lift the market back up.
And guess what? Support levels aren’t just for bear markets. Even in a bull market, as it zigzags upward, it can hit higher and higher support levels. You can easily spot these support areas on charts of any timeframe. Some people even call them the “base” or the “floor”.
What is a Resistance level?
Resistance is basically an area on a market’s chart that it struggles to break through and reach new highs. It’s the opposite of support. So when an asset hits it, sellers take over and push its price back down again.
Resistance levels can come into play during both bear and bull trends. People often call them the asset’s ‘ceiling’. You might also hear someone say that a market is ‘rangebound’, which just means that its price is stuck between its support and resistance levels.
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How do Support and Resistance work?
Support and resistance mark the levels or zones where you can enter or exit a trade. The price either reverses from these levels or breach and continue the current trend. If a pair’s price breaks support or resistance, the price often continues to the next level of support or resistance level or area. Support and resistance levels are not always exactly as they can be an area or price range. They help identify possible areas where price may change directions.
How do Support and Resistance differ across financial markets?
Support and resistance levels play a crucial role in various financial markets, like important markers delineating where prices often halt or change direction. Let’s delve into how these levels differ across different market landscapes:
- Stocks: Within the stock market, support and resistance levels are significantly influenced by a company’s performance, encompassing factors such as financial earnings and major news developments. Due to the frequent price fluctuations, these levels are prone to frequent breakouts.
- Forex: In the forex market, support and resistance levels hinge upon significant global occurrences, including government-set interest rates and international events. Given the bustling nature of forex markets, these levels are more visible and easier to utilize.
- Commodities: Within the commodities market, support and resistance levels are intrinsically tied to supply and demand dynamics of key resources like food and oil. This market tends to exhibit more predictable price patterns at specific times, making these levels invaluable.
- Cryptocurrencies: The cryptocurrency market sees support and resistance levels influenced by market sentiment, ongoing news developments, and technical factors such as mining complexity. Due to the inherent volatility of cryptocurrencies, utilizing these levels for trading poses greater challenges.
In summary, support and resistance levels can serve as valuable tools across all financial markets, aiding traders in strategizing their entry and exit points. However, it’s important to recognize that the specific factors influencing these levels may vary significantly depending on the respective market.
What is the Importance of Support and Resistance in Trading?
Lots of traders use support and resistance to help them determine the perfect entry and exit strategy.
Let's take a simple example. If a support level has been hit multiple times but hasn't been broken, it might be a good opportunity to buy. You can open a long position near that support area and try to make a profit if the market bounces back. On the other hand, you could open a short trade near a resistance level to take advantage of any downward price reversal.
When it’s time to close a position, you can identify a level where a price reversal might happen to maximize your profit or limit your loss. But keep in mind that support and resistance levels aren’t set in stone and can be broken. Sometimes when a market breaks through a well-established support or resistance level, it can move toward the next one.
This brings us to another trading strategy: Opening a position when a market surpasses its support or resistance level and trading the subsequent move. However, it’s important to remember that nothing is guaranteed in the markets. They can be influenced by various factors.
Now, let’s talk about major and minor levels. Not all support and resistance levels are equal. Minor levels can temporarily slow down price movements within a larger trend, while major levels have the potential to halt or even reverse a trend completely. The more times a market bounces off a support or resistance level, the stronger it’s considered to be. For instance, if EUR/USD struggles multiple times to rally past 1.1965, a major resistance level may form.
Traders’ mindset often reinforces support or resistance levels. After EUR/USD bounces off 1.1965 a few times, many traders might decide to short the market there, further strengthening the level. If a market breaks through a major level, it could lead to a significant move in that direction, which is known as a breakout.
There's one more thing to note about support and resistance. Support can turn into resistance, and vice versa. For example, an area of support during a bearish move can become resistance if sentiment turns positive. Similarly, a previous resistance level can act as a new area of support.
Look at the example above again, where the minor resistance levels in one move become minor support levels in the next. By analyzing the previous trend, you can gain insight into what might lie ahead when planning your trading strategy after a price reversal.
How to Apply Support and Resistance in Trading?
A support level is a point on a market chart that shows when traders are ready to buy. The best way to use support and resistance is to watch for two things: breakdowns and breakouts. A breakdown happens when an asset falls below the support level. On the other hand, a breakout occurs when an asset rises above the resistance level.
Some traders use support breakdowns by selling an asset when they think it will keep going down, so they can limit their potential losses. They may have noticed that the asset continued to drop after it fell below the diagonal support line. Other traders keep an eye on assets near the resistance level and buy them once they experience a breakout above that level.
For example, a trader might buy an asset on the day it breaks above the resistance level and then make a profit in the following days. So, selling assets that break below support or buying assets that break above resistance are a couple of ways to use support and resistance in trading.
Support and Resistance Trading Strategies
Support and resistance levels can be traded using a variety of trading strategies. Traders commonly use the following strategies:
Trend trading Strategy
The trend trading strategy utilizes the trendline fulcrum points as either support or resistance, by simply drawing a line connecting two or more highs in a downtrend or two or more lows in an uptrend. A strong trendline will let prices bounce off the trendline and continue to move in the direction of the trend.
Breakout and Pullback Strategy
Usually, after a period of directional uncertainty, the price will eventually surpass these levels and begin a new trend. Traders often search for such breakouts below support or above and buy/sell on increasing momentum in the other direction. If the momentum is strong enough, a new trend will be started. In some cases, to avoid falling into the trap of trading the false breakout, traders tend to wait for a pullback towards support or resistance before entering a trade.
Range Trading Strategy
Range trading is the price level range between support and resistance where traders aim to buy at support and sell at resistance. Usually, ranges tend to appear in sideways trading markets where there is no clear indication of a trend. A range-bound market means that traders are long when the price bounces off support and short when the price retreats from resistance.
What is the Best Support and Resistance Indicator?
While there are several support and resistance technical indicators available, there is no universal “best” indicator. Each trader’s trading style, preferences, and type of market determines what indicator to use.
Some popular support and resistance indicators include:
- Horizontal Support and Resistance Levels: These lines are drawn across a price chart to connect multiple lows (support) or highs (resistance) that the price has struggled to move past in the past.
- Fibonacci Retracement Levels: Drawn according to the Fibonacci sequence, these levels indicate potential support and resistance levels for the retracement of price movements.
- Moving Averages: Moving averages, such as the 50-day or 200-day moving averages, are sometimes used as dynamic levels of support and resistance, particularly in trending markets.
- Bollinger Bands: Bollinger Bands are made up of an upper and lower moving average and a middle moving average. These bands can serve as dynamic support and resistance levels, causing prices to react.
- Pivot Points: Pivot points are determined by the high, low, and close price of the previous day. A support or resistance level can serve as a trading day support or resistance level.
- Ichimoku Cloud: Ichimoku Cloud provides multiple lines, including Kijun-sen and Tenkan-sen, which can be used to identify dynamic levels of support and resistance.
Using a combination of indicators can help traders confirm support and resistance levels. The best way to determine which indicators or strategies will work for your trading style and objectives is to test them on historical data and in a risk-controlled environment like a demo account.
Support and Resistance Role Reversal
One of the common concepts in forex technical analysis is that when a resistance or support level is broken, its role is reversed. That means if the price breaks or falls below a support level, that level will become a resistance level. On the other side, if the price rises above a resistance level, it will often become a support level instead. As the price breaches a level of support or resistance, the supply and demand are inverted, causing the breached level to reverse its role.
Why technical analysis is important for forex trading?
According to studies, most successful forex traders rely on technical analysis to study the market. In the forex market, traders can use technical analysis to analyze the major pairs, Gold, and cryptocurrencies. Technical analysis is a common method used by investors to analyze the financial markets. The main benefit of learning forex technical analysis is to identify the relationships between price/volume and market indicators such as the moving average.
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