Support and Resistance

It is important for a chart trader to understand the concept of support and resistance.

A chart reveals levels at which the market has previously turned. These levels may be price peaks the market reached before pulling back, or low points reached before the market bounced. The peaks form resistance and low points form support. Support and resistance levels can be found in any time frame.

The more frequently price pulls back from a particular price level, the stronger the resistance. The more often price rebounds from a low point, the stronger the support. (Note that support and resistance levels are bands rather than specific points. e.g. A contract may have earlier price peaks at 825.6 and 825.8. Given this information, an analyst might designate resistance at 825.5 – 826.0.)

When price breaks through resistance, the penetrated resistance level becomes a support level. Similarly, when price drops through support, the penetrated support level becomes resistance.

Professional traders understand that support and resistance levels act like a magnet for trading activity. If price is moving upward toward a resistance level, then clearly there is upward price pressure. However, as the resistance level is approached selling increases because some traders in long positions will target this resistance level to sell and take profits, and others, knowing price pulled back from here previously, will open short trades by selling at the resistance level. If increased selling activity overpowers the buying pressure, price will once again pull back from the resistance level, further reinforcing its strength. But if the underlying buying pressure is strong enough to overcome the increased selling and price penetrates the resistance level, a flurry of further buying activity is triggered because many traders who sold short approaching resistance place buy (stop loss) orders just above resistance to close their short trade with a small loss, while others see the penetration of resistance as a breakout from the current price range and enter new long positions.

In this scenario, the trader observes a steady price move towards resistance where it stalls on higher trading volume as bulls (buyers) and bears (sellers) struggle for ascendancy. If resistance is penetrated and the upward move continues, a sharp price rise often follows as extra buying hits the market. If resistance holds, the pullback may also be rapid if other traders in long positions decide to liquidate their positions.

When price is moving downwards towards support, the exact opposite range of forces come into play. As support is approached, some traders in short positions will buy to take profits. Others will buy to open new long trades, hoping for a rebound from support. If this increased buying overcomes the selling pressure, price bounces off the support level. When this encourages other traders to bale out of their short positions, or others to enter new long positions, a sharp swing upward can be triggered.

If, however, the downward pressure is strong enough to resist the increased buying and force price through the support level, then those traders who went long at the support level are likely to have their stop loss sell orders triggered, and other traders will be encouraged by the downward break of support to enter new short positions. This flurry of selling often leads to a quick spike down in price.

There is no infallible method of predicting the outcome of skirmishes fought between bulls and bears at support/resistance levels. As always in trading, it is best to bet with the odds. To do that it is necessary to look at price movement in a longer time frame than that in which you are trading, and assess whether the overall price trend is up, down or sideways.

In an up-trending market, support levels tend to hold and resistance levels tend to get broken.

In a down-trending market, resistance levels tend to hold and support levels tend to get broken.

In a sideways market, price often seems to be moving in a range. Resistance at the top of the range tends to hold. Support at the bottom of the range also tends to hold.

An understanding of support and resistance principals enables an enterprising person to formulate any number of satisfactory trading tactics. A trader who thoroughly internalises understanding of support and resistance principles seldom needs more. Do not make the mistake of skipping this topic in a rush to study more sophisticated technical indicators.

Especially avoid the trap of endlessly searching for an indicator, or combination of indicators, which is always right. No such indicator exists. Trading is a process involving losses as well as wins, and successful traders accept losses as part of the business. Profits derive from consistently applying strategies with positive expectancy and using a good money management plan.

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