Understanding support and resistance

Understanding support and resistance

You might have heard the terms support and resistance before. Support and resistance form fundamental aspects of the financial markets and are highlighted at the very early stages of a trader’s career.


Support and resistance areas are prices or zones of prices that indicate excess supply or excess demand. They are called areas or zones as demand or supply do not come in at one single level and instead, are spread out over a range of prices.


Let’s start by looking at an example of a support area on the Dow Jones Industrial Average Index (Figure 1):

Figure 1


In the example, you can see two rectangles where price each time paused and reversed higher. The first time might have been some profit taking action, leading to a short term reversal while the second instance led to a broader and bigger move in the opposite direction. Support zones indicate demand, either in the form of traders squaring some old positions or full-on demand and initiated positions.


Let’s look at an area of resistance (Figure 2):


Figure 2


You can see the first rectangle helped pause the ascent for a bit but then the trend resumed only to stop on a bigger area of resistance, one that showed price failing multiple times. If you notice, the two rectangles are relatively close in terms of price which indicates that the entire area is exhibiting increased supply, enough to stop the advance of the uptrend.


Support and resistance zones not only help you determine when the market may reverse in the future but it can also tell you what to expect in case an area is overcome. For example, the area of resistance above is capping prices but in the event a surge of demand comes in and forces price higher, the market could see further upside as those traders who are short are now caught in the negative, forcing them to reverse positions and create even more demand on the buy side.


Integrate supply and demand into your daily analysis or trading strategy as it helps you pinpoint areas where you can place your stop loss or take profit orders. Keep in mind that support and resistance zones are not perfect and a certain market may reverse before reaching one while other times may see price briefly pushing through resistance or support only to reverse to the other side, effectively creating a fake breakout.


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