How to Trade with Support and Resistance
In this article, I am going to discuss How to Trade with Support and Resistance in Trading. Please read our previous article where we discussed Head and Shoulder Patterns in Trading. As part of this article, we are going to discuss the following pointers in detail which are related to How to Trade with Support and Resistance.
- What are support and resistance?
- How to Trade with Support and Resistance?
- The psychology behind support and resistance
- Support resistance level vs zone
- Types of support and resistance
- Multi-time frame support and resistance
- Where support and resistance formed?
- Strength of support and resistance
- When support and resistance break?
What are SUPPORT AND RESISTANCE?
Support, as the “buying, actual or potential, sufficient in DEMAND to halt a downtrend in prices for an appreciable period.” and possibly reverse it, start prices moving up again. Fair price for buyers and risk to reward is more
Resistance, as the selling, actual or potential, insufficient supply to keep prices from rising for a time, and possibly turn back its uptrend. Fair price for sellers and risk to reward is more
These price levels constantly switch their roles from support to resistance and from resistance to support. A former resistance, once it has been surpassed, becomes a support zone in a subsequent downtrend; and old support, once it has been penetrated, becomes our resistance zone in a later advancing phase.”
Why are Support and Resistance important?
These points are not random, they are created by the market. They represent momentary changes in demand and supply forces. The bulls could not move the market above the swing high. This means that at that point in time, no one was willing to offer a price higher than the swing high. Traders saw no value above the swing high
Hence, subsequently, when the price moves close to or near, or above a wing high, we must remember that traders saw no value in buying above that point previously. Assuming that most traders have not changed their opinions, prices are unlikely to move above the swing high. Effectively the swing high mark a price area that resists the market from moving up this is what we call a resistance area. Reverse for support area
Once the structure of the market know, then find which phase the market is currently in (accumulation or distribution or up or down)
The Psychology of Support and Resistance
To illustrate, let’s divide the market participants into three categories the longs, the shorts, and the uncommitted. When price comes to the support level
- The longs are those traders who have already purchased contracts;
- The shorts are those who have already committed themselves to the sell-side;
- The uncommitted are those who have been out of the market or remain undecided as to which side to enter.
Traders with the fear of missing out would enter their trades the moment the price comes close to Support to get at a cheap price. And if there’s enough buying pressure; the market would reverse at that location.
Let’s assume that a market starts to move higher from a support area where prices have been fluctuating OR accumulating for some time.
The longs are delighted but regret not having bought more. If the market would retrace back near that support area again, they could add to their long positions.
The shorts now that they are on the wrong side of the market. The shorts are hoping (and praying) for a dip back to that area where they went short so they can get out of the market where they got in (their break-even point).
The final uncommitted group, now realizes that prices are going higher and resolve to enter the market on the long side on the next good buying opportunity.
All four groups are resolved to “buy the next dip.” They all have a “vested interest” in that support area under the market. If prices decline near to support, renewed buying by all four groups will push the prices up
Now let’s turn the tables and imagine that, instead of moving higher, prices move lower. In the previous situation, because prices advanced, the combined reaction of the market participants caused each downside reaction to be met with additional buying (thereby creating new support). However, if prices start to drop and move below the previous support zone, the reaction becomes just the opposite. All those who bought in the support zone now realize that they made a mistake.
All of the factors that created support by the three categories of participants—the longs, the shorts, and the uncommitted—will now function to put a ceiling over prices on subsequent rallies or bounces. As all of the previous buy orders under the market have become sell orders over the market. The support zone has become a resistance zone
Support and Resistance Level and Zone
Support and Resistance Level is more detailed and different levels with the zone. The level is one line and Zone is Zone. In practice, support and resistance and supply and demand zones are formed from the same origin
Support and Resistance are areas and not lines
Because you’ll face these two problems:
- Price “undershoot” and you miss the trade
- Price “overshoot” and you assume support and resistance is broken
Let me explain…
Price “undershoot” and you missed the trade. This occurs when the market comes close to the support and resistance line, but not close enough.
Then, it reverses back in the opposite direction. And you miss the trade because you were waiting for the market to test your exact SR level. This price reversal is also called 123 reversals. Or holding a higher level of support or lower level of resistance, THIS IS GENERALLY OCCURS DUE TO THE AGGRESSIVE BUYERS AND SELLERS
An example: OF PRICE UNDERSHOOT
Price “overshoots” and assume support and resistance are broken
This happens when the market breaks support and resistance levels and you assume it’s broken. Thus, we trade the breakout but only to realize it’s a false breakout. THIS TYPE OF PRICE ACTION IS CALLED UPTHRUST AND SPRING
Let’s DO AN EXAMPLE OF PRICE OVERSHOOT
So, how do you solve these two problems?
Simple, Support and Resistance are areas on the chart, not lines.
How to draw support and resistance zone
A two-step process to fins SR ZONE
- Step 1 switch to a line chart and mark the line with the rejections.
- Step 2 again switch to the candlestick chart, mark the high or low of the candle near the marked line, and make the zone
Let’s do an example of drawing an SR zone
TYPES OF SUPPORT AND RESISTANCE
- Dynamic(moving average)
- Trend line
LET’S FIND ALL THE ABOVE SUPPORT AND RESISTANCE IN A SINGLE CHART
Multi timeframe SUPPORT AND RESISTANCE
- The power of support and resistance depends on the time frame we are looking at, the higher the time frame the higher the probability of it work
- Through all the timeframe support and resistance work but the rewards grow the higher the timeframe is
- The noise in the lower time frame chart is more
Using the higher time frame and top-down analysis, put more weight on the higher time frame SR level.
To focus on major support and resistance levels, first, find them on higher time frames before applying them to your trading time frame for analysis.
For example, you can note down the support and resistance levels from the weekly chart. Then, plot them on the daily chart to find trading opportunities. This method keeps you focused on important support and resistance levels instead of flooding your chart with dozens of potential support and resistance levels.
WHERE SUPPORT AND RESISTANCE DEVELOPED?
- The first point of support in any time frame is the prior bar’s high
- The first point of resistance in any time frame is the prior bar’s low
- The second points of support and resistance are pivot points(swing high and swing low)
- Consolidation area
- Rejection from an area
- Previous has acted as both support and resistance
- Gap(invisible tail), EMOTIONAL POINT
- Fibo retracement
- Trend line and MA
Rejection from an area
LAST SWING HIGH AND LAST SWING LOW
Swing highs and swing lows are market turning points. They are natural choices for projecting support and resistance zones
Smart money has spent a prolonged time in the congestion area. They have established actual trading interests within that price range. Hence, earlier market congestion areas are reliable support and resistance zones
MA AND FIBO RETRACEMENT
You can also derive support and resistance from the moving average. They work best in trending markets.
Fibonacci retracement is a popular method for projecting support and resistance. We can mark out retracement levels easily. Hence Identify major market swings and focus on the retracement of the move by a Fibonacci ratio. Generally Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8% and 100%.
FLIPPING OF SUPPORT/RESISTANCE
Flipping act as both support and resistance. Support turned into resistance or resistance turned into support. When the price breaks through a resistance level, it shows a shift of power from sellers to buyers. The resistance level then becomes support.
How strong support and resistance
There are a number of factors that should be considered in determining how significant or strong the support or resistance level will be. These factors are as follows:
- The number of occurrences. The first-time retrace to the area is strong
- Volume. The higher the relative volume is at a particular price level, the more likely it is that the price level will become significant support or resistance.
- How did the price leave the level? The stronger the price moves away from a zone, the more out-of-balance supply and demand are at that zone. A heavy order is placed by smart money
- How much time did the price spend at the zone? The less time the price spends at a zone, the more out-of-balance supply and demand are at the price level. Smart money aggressively entering When prices retrace and test the level in future
- How far did the price move away from the zone before returning back to the zone? The farther price moves away from a zone before returning to that zone, the greater the reward to risk and probability.
When support and resistance break
And even when prices start to falter in the higher region of the chart, bulls are technically still in control as long as they manage to keep the market up in levels higher than or equal to a former significant low. But the stronger the earlier dominance, the less likely the market will turn on any first reversal attempt.
- Support tends to break into a downtrend
- Resistance tends to break into an uptrend
- Support and Resistance tend to break when there is a tight range at the SR level
- The more/frequently test of support resistance is weakening this level and break the level
The more times Support or Resistance (SR) is tested, the weaker it becomes and breaks the level
The market reverses at RESISTANCE because there is selling pressure to push the price lower. The selling pressure could be from Institutions, banks, or smart money that trades in large orders.
Imagine this: If the market keeps re-testing resistance, these orders will eventually be filled. And when all the orders are filled, who’s left to sell?
It shows that participants are more aggressive to push/pulling the price to break the resistance/support. While the higher low toward resistance indicates aggressive by the buyers
LET’S DO AN EXAMPLE
Higher lows into Resistance usually result in a breakout (formed ascending triangle). Lower highs into Support usually result in a breakdown (formed descending triangle).
Resistance tends to break into an uptrend
For an uptrend to continue, it has to consistently break new highs. So, shorting at resistance is a low probability trade in an uptrend. Instead, going long at Support is a better trade or break out from the last high
Support tends to break into a downtrend
For a downtrend to continue, it has to consistently break new lows. So, going long at support isn’t a good idea in the downtrend. But, going short at Resistance is a great idea or breakout from last swing low
Support and Resistance tend to break when there’s a tight range
Resistance is an area with potential selling pressure. So, the price should move up quickly, right?
Now… what if the price didn’t move down and instead, consolidates at resistance?
What does it mean?
A sign of strength as the bears couldn’t push the price lower. Perhaps there’s no selling pressure or there is strong buying pressure. Either way, it doesn’t look good for the bears, and resistance is likely to break. An example:
And the opposite for Resistance:
In the next article, I am going to discuss Advanced Candlestick Analysis in Trading in detail. Here, in this article, I try to explain How to Trade with Support and Resistance in detail. I hope you enjoy this How to Trade with Support and Resistance article. Please join my Telegram Channel and YouTube Channel as well as my Facebook Group to learn more and clear your doubts.