What are support and resistance?
Among the many different ideas that form technical analysis, one of the most important ones would have to be support and resistance. Nearly all trading strategies use support and resistance in one way or another, and if they do not, can benefit from its addition.
Support is an area (Figure 1) where price pauses or reverses due to already-present or sudden demand in a specific trading product. Demand comes in the form of new buying, taking profit on short positions, or a combination of both. Whatever the reason, when you see price stops and pauses or reverses temporarily, know that this area is seeing demand and can be considered a support zone.
The opposite is also true. If you see (Figure 2) price moving higher and suddenly pauses and consolidates for a bit or reverses lower, know that this area is a zone of resistance, characterized by renewed selling or profit-taking on long positions.
It’s important to remember that support and resistance are not exact levels but zones where small, medium, or large scale buying or selling comes in.
Horizontal support and resistance
Support and resistance can either be horizontal or diagonal. Horizontal support and resistance are the more powerful kind as they are occurring naturally without drawing trendlines or chart patterns. Such areas are seeing supply and demand at their best, enabling flow to stop or reverse a certain market.
Figure 1
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Figure 2
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Let’s take a look at the following example of horizontal support. You can see how price has been trending lower, paused, consolidated for a bit, then reversed higher, indicating that demand managed to overcome supply and drove price higher again. While this is not always the case every time a support zone shows up, it’s a place of interest for traders because if that support holds, then this area will serve (Figure 3) as an important zone to watch in the future in terms of support. On the other hand, if it breaks, the area will turn to resistance where sellers will look to protect it from buyers attempting to push the price higher.
Now let’s look at an example of a resistance zone. Here, you can see how the price was moving higher and stopped. The reversal did (Figure 4) not come through and the price eventually broke the resistance area and moved higher. This zone is now considered a support zone, where the price is likely to drop towards it and buyers will look to protect it from sellers attempting to reverse the entire structure.
Figure 3
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Figure 4
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Diagonal support and resistance
Diagonal support and resistance areas are created through the use of trendlines. Occasionally, we may see markets moving higher or lower in a rather structured manner, resembling a set of stairs where there are corrections in between new peaks or troughs. Let’s look at the following example of an uptrend where it’s possible to draw a trend line.
You can see how the trend line is acting (Figure 5) as support with price reversing every time it touches the trend line. This is not an exact science but can play an important role in helping you secure a better entry when attempting to buy in an uptrend.
Figure 5
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It’s important to combine Fibonacci retracements (Figure 6), price action, and horizontal support and resistance when using diagonal support and resistance. It will give traders better confirmation and more confidence before entering a trade. This should be the case for anyone using technical analysis and having multiple confirmations is key to improving odds and possibly creating success.
Minor and major levels
Support and resistance areas are not uniform in strength or reaction. Some areas may be minor, leading to small consolidation or a quick correction while bigger areas can have a stronger effect and could lead to reversals or major breakouts.
Figure 6
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The rule of thumb is, the more an area is acting as support or resistance, the more significant and major it is where traders can anticipate a major move when the price reaches it again. This is why patterns such as double and triple tops and bottoms are very powerful, mainly because the price has already paused multiple times so they become a critical point for the future of that specific product.
Combine major areas with minor ones and you could create a roadmap of trading for yourself. In other words, if you know the market is sitting at a major support zone, find the next minor resistance area and wait for it to break. From there, use it as minor support to add to your position or simply move your stop to secure your trade.
Trading around support and resistance
In hindsight, trading around those areas can be highly profitable but in reality, emotions need to be removed when you are looking to buy or sell near those zones. This is because the price can play tricks and affect your psychology especially when fake breakouts are involved.
Ideally, you should structure your plan and trading thoughts in the following manner:
- Identify the main trend
- Highlight the support and resistance zones on your chart
- If the trend is up, you are looking to buy at the next significant support area
- Once price reaches that support area, apply your trading system
- This means using price action to confirm a reversal higher
- You can also use indicators or candlestick patterns
- Add a stop to your position to protect it from a sudden break of support
- Add a target that gives you a decent risk to reward ratio
- Keep an eye for a break of the support zone, at which point you can consider a sell position to benefit from the new reversal momentum
You can apply the same logic when the trend is down by selling near the resistance area.
If you prefer using candlestick patterns, then you are looking for a Hammer pattern (Figure 7) near support zones in an uptrend or a Marubozu.
Figure 7
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When looking to sell, you can look for patterns such as a (Figure 8) Hanging Man near resistance or a bearish Marubozu. A shooting star near highs can do wonders if confirmed by bearish candles afterward.
For those of you who enjoy riskier trades or do not mind trading against the trend, you can choose to trade support and resistance zones regardless of the main trend or simply focus on a smaller time frame. This could create new opportunities but occasionally risky ones that may fail.
If you prefer using candlestick patterns, then you are looking for a Hammer pattern (Figure 7) near support zones in an uptrend or a Marubozu.
Stay ready to trade the other side if major support or resistance areas break. In this case, momentum will go to the other side and could provide opportunities. While traders prefer not to do this because it could be a fake breakout, it makes sense to participate because the move of the day or the week could be just on the other side of that support or resistance zone.
Figure 8
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Putting it all together
Trading support and resistance levels are no secret or magic. It’s one of the most overlooked trading concepts and most traders fail to apply it properly despite how simple it is. Identify the main trend, look for support and resistance zones then apply your trading strategy or commonly used indicators, candlestick patterns, or chart patterns and take positions. Remove emotions completely as the price can whipsaw near those areas and make sure your risk to reward ratio is skewed in your favor so that you can build towards creating trading consistency.