Support and resistance

Support and resistance

Support and resistance lines are the most important attributes of technical analysis, in fact I should say that technical analysis itself are based on them. They areΒ  higher highs and lower lows but wait, they are always more than that. Why do they work? Because those levels mean something. Support is a price bellow the current price where the demand is stronger than supply, at that level we should expect a bullish momentum. Resistance is exactly the opposite: the supply exceeds then the demand and bearish come into places because there is no demand and everyone tried to get rid of a higher supply.
Support and resistance lines along with high impact news give us clues about the future. If resistance lines are broken an uptrend is to be expected, otherwise the price will fall close to the previous support line. If support lines are broken, then more and more traders are willing to get rid of their supplies and more bearish trend is to be expected. Once broken, a support line becomes the resistance line. and, of course, if broke, the resistance lines becomes a support line.

Support and Resistance lines

Support and Resistance lines

There is no algorithm that helps us in defining those levels, it’s more of an art than science. Support levels are defined as lower lows and resistance levels are higher highs but they become support and resistance lines only if strong rejection is observed around those levels.

Support Resistance Example

Support Resistance Example

There is a strong rejection near 1 and 5 levels so they are real resistance(1) and support(5) lines, the other lines are fake support and resistance lines even if they are higher highs and lower lows because there is no strong rejection near them. Please take into consideration that each timeframe has its own support and resistance lines! If you are an intraday trader (small stop loss is used) then you should look for those lines on M15 and M30 timeframes. If you are a day trader you should use a stop loss close to previous day high – previous day low and look for support and resistance lines on daily and weekly timeframes. But if you want the overall long/medium term pictures, all timeframes should be looked into.

A million dollar question is: how should I use these lines? Should I bet that on rejection or continuation of the trend (breakout) near those lines?
Any of these will do. At first, I bet on rejection, with a tight stop loss. Then, if the level is broke, I wait for a continuation sign and place my stop a few pips above/bellow the line (please remember that once broken the support becomes resistance and resistance becomes support).

In reality the resistance and support lines are not fixed numbers, but price zones. Drawing those lines is not enough you have to find out the actual direction of the trend by drawing trend lines and then find the support and resistance zones according to the trend direction.

Trend direction

Trend direction

When the trend ends, a strong rejection is observed followed by long candles that broke the trend line. This is a clear sign that the actual trend ends.

There is a well known principle of technical analysis: do not trade against the trend, trend is your friend, until it ends. πŸ™‚ Trading with the trend doesn’t mean chasing the market, the most profitable method is trading the pullbacks.

How to spot pullbacks? Suppose a resistance lines is broken and it becomes support line. The price goes up and up, then it retraces until it retests the support line. This is called pullback and gives you wonderful trading opportunities. All you have to do is to place a trade with a very tight stop loss.

An image makes a thousand words and here is the best image I found while searching trough google images:

 

Pullbacks

Pullbacks

Pretty neat, ah?

The most common mistakes make by rookies are the following:

1. To enter short right after the price rose above resistance zone
2. To enter long right after the price went bellow support zone3. Breaking of a trendline doesn’t mean that the trend changes its direction, the market could go sideways instead before a new continuation of a trend. But if it breaks the trendline that joins the higher highs then yes, we can interpret this as a change in direction.

Please read them once again and don’t repeat those mistakes, if you read and understand well this article, you are no longer a rookie. πŸ™‚

I hope you enjoyed reading, if yes, please share πŸ™‚