There are few concepts as universally acknowledged and heavily relied upon as support and resistance. These two terms are more than just buzzwords; they represent crucial landmarks on price charts, guiding traders on potential future price movements. The importance of understanding support and resistance cannot be overstated.

Whether one is deciphering the support and resistance levels of a popular stock or utilizing a support and resistance indicator on platforms like MT4 or TradingView, these markers provide invaluable insights. They help delineate potential entry and exit points, predict potential breakouts, and gauge market sentiment.

As we delve deeper into this topic, we’ll explore the nuances that differentiate simple horizontal barriers from complex zones and even touch upon how supply and demand interplay with these levels.

Welcome to the intricate, yet rewarding, universe of Support and Resistance.

What is Support and Resistance?

Support and Resistance are fundamental concepts in technical analysis and are used by traders and investors to identify price levels on a chart where the price of an asset tends to pause or reverse. These levels act as psychological barriers for the market participants and can often influence trading decisions. Here’s a detailed breakdown:

1. Support Level:
   • This represents a price level at which an asset tends to find buying interest and where it historically has had trouble falling below.
   • It’s as if the asset is receiving “support” at this level, preventing the price from dropping further.
   • Factors contributing to the emergence of a support level might include: traders remembering a past level where the asset was a good buy, causing them to start buying again when it reaches that level, or basic principles of supply and demand.
2. Resistance Level:
   • This is the opposite of a support level. It’s a price level where a security or market tends to face selling pressure.
   • Historically, when the price reaches this level, the asset often struggles to break through it and rise further.
   • The resistance level acts as a ceiling because, as the price rises towards resistance, it faces increased selling or supply which can halt or reverse the upward trend.

Reasons for the Existence of Support and Resistance:

• Psychological Factors: Round numbers, such as $50 or $100, often serve as resistance or support levels because they are psychologically appealing entry or exit points.
• Historical Factors: Past lows and highs can establish future support and resistance levels. Traders remember these levels and are likely to use them in their trading decisions.
• Technical Factors: Tools and methods such as moving averages, Fibonacci levels, and trendlines can create perceived levels of support and resistance.

Importance of Support and Resistance:

• Helps traders identify potential points of entry and exit.
• Provides clues about the future price movement of an asset. For instance, a breakout above resistance could signify a continued upward trend.
• Offers risk management cues, allowing traders to set stop-loss orders near support or resistance levels.

How to Identify Support and Resistance?

Support and resistance levels are fundamental concepts in technical analysis, and while they might seem straightforward, several rules and guidelines can help traders accurately identify and make effective use of these levels.

Here are some key rules and insights concerning support and resistance:

1. Role Reversal: Once a support level is breached, it can become a resistance level and vice versa. For instance, if the price of an asset breaks below a support level, that same level might act as resistance when the price tries to move back up.

2. Confirmation is Key: A single touch of a price level doesn’t confirm it as support or resistance. The more times a price touches a support or resistance level without breaking it, the stronger that level is considered.

3. Price Zones, Not Exact Numbers: Rather than being an exact price number, support and resistance often work within a small range or zone. Markets don’t turn on a dime, and a few points above or below the perceived level can still be considered a touch.

4. Round Numbers: Psychological levels, like round numbers, often serve as support and resistance. For instance, levels such as 10, 50, 100, 1000, etc., can be significant because they’re seen as psychological milestones.

5. Previous Highs and Lows: Past significant highs can act as resistance, while lows can act as support. This is because traders remember these levels and make decisions based on them.

6. Volume Matters: A breakout or breakdown from a support or resistance level with high volume is often seen as a stronger signal compared to one with low volume. Volume can be used as a confirmation.

7. Duration of the Level: The longer a support or resistance level holds without being broken, the more significant it becomes.

8. Trendlines: Support and resistance levels don’t always have to be horizontal. They can be diagonal, forming trendlines that connect highs or lows.

9. The Stronger the Move, the Stronger the Level: If the price dramatically rises or falls to a support or resistance level, the level is likely to be stronger than if it slowly approaches the level.

10. Breakout Confirmation: A genuine breakout or breakdown should be followed by a continuation in the direction of the breakout, and not quickly reverse. It’s not uncommon to see false breakouts, which is why some traders wait for confirmation.

10. Rejections and Closures: Watching how candles close in relation to support or resistance can give clues. For instance, a long wick rejecting a level indicates that there’s significant pressure from that level.

11. Use with Other Indicators: While support and resistance can be powerful on their own, they’re most effective when combined with other technical analysis tools, such as indicators, chart patterns, or trend analysis.

How to Draw Support and Resistance

Drawing support and resistance levels accurately is crucial for making informed trading decisions. Here’s a step-by-step guide to help you pinpoint and draw these pivotal price levels on a chart:

1. Choose the Right Chart Type: Start with a ‘candlestick’ or ‘bar’ chart for a clearer view of price action compared to a line chart.
2. Decide on a Time Frame: Depending on your trading strategy—whether you’re a day trader, swing trader, or long-term investor—select an appropriate time frame. Remember, support and resistance levels can be identified on any time frame, from 1-minute charts up to monthly charts.
3. Identify Clear Swing Highs and Lows: Look for obvious points where the price changed direction. These can be:
   • Swing Highs: Peaks or areas on the chart where price reached a high and then reversed.
   • Swing Lows: Troughs or areas where the price hit a low and then reversed.
4. Draw Horizontal Lines:
   • Place a horizontal line at the swing high to represent potential resistance.
   • Place a horizontal line at the swing low to indicate potential support.

These horizontal lines help you visually anticipate where the price might find support or resistance in the future.

5. Incorporate Diagonal Trendlines: Not all support and resistance lines are horizontal. If the asset is trending:
   • Draw an ascending line connecting the higher lows in an uptrend. This line acts as a dynamic support.
   • Draw a descending line connecting the lower highs in a downtrend. This line serves as a dynamic resistance.
6. Adjust and Refine: As you gather more data and the asset price evolves, you may need to adjust your lines. Sometimes minor adjustments can provide a clearer perspective on potential breakout or bounce points.
7. Use Technical Indicators: Some technical indicators can help identify potential support and resistance zones. For example:

• Moving Averages: Especially commonly used ones like the 5, 30, and 62 moving averages can act as dynamic support or resistance levels.

•  Fibonacci Retracement: This tool, based on the Fibonacci sequence, identifies potential retracement levels that can act as support or resistance.

8. Review Periodically: Periodically review and clean up your charts. Over time, certain support and resistance levels may lose their relevance, and keeping them might clutter your analysis.

How to Trade Support and Resistance

Have you heard of the terms ‘the bounce‘ and ‘the break‘?

The concepts of “the bounce” and “the break” are pivotal when dealing with support and resistance in technical analysis. Understanding these two scenarios can aid traders in making informed decisions.

The Bounce

When the price approaches a support or resistance level and then reverses direction, this phenomenon is referred to as “the bounce.” This suggests that the support or resistance level is holding, and there’s enough buying or selling pressure to push the price up or pull the price down once it hits that level.

The Break

Sometimes, rather than bouncing off a support or resistance level, the price will move through it, indicating a potential change in the market dynamics. This action is termed as “the break.”

When a support level is broken, it can turn into a new resistance level, and on the other hand, once a resistance level is breached, it might act as a new support level.

How to Enter a Trade After The Bounce or The Break

Deciding where to enter a trade after observing a bounce or a break is crucial, as the entry point can significantly impact the risk-reward ratio and the probability of the trade’s success. Here’s a guideline for potential entry points after a bounce or a break:

After The Bounce

Bounce from Support

Some traders enter as soon as they observe a bounce from the support level. This method requires confidence in the identified support and a clear bounce, which might be confirmed by bullish candlestick patterns like hammer or bullish engulfing right at the support level.

Others might wait for a minor pullback after the initial bounce to get a better entry point. This is for those who might have missed the immediate bounce or want additional confirmation.

Bounce from Resistance

If selling/shorting after a bounce from resistance, traders might enter immediately after recognizing a clear rejection. This could be confirmed by bearish candlestick patterns like shooting star or bearish engulfing.

You can also wait for a slight upward pullback after the initial rejection to sell at a slightly higher price. This is for traders seeking better entries or who might’ve missed the initial bounce.

After The Break

I recommend you always enter a trade after a Pull back.

Break of Support

Immediate Entry: As soon as the price breaks and closes below the support, some traders might decide to sell/short. However, this can be risky due to potential false breakouts.

Retest Entry: A more conservative approach is to wait for the price to break the support, then move up to retest the broken support (which now acts as resistance) before continuing its downward move. Entering a short position on this retest can be a safer strategy.

Break of Resistance

Immediate Entry: Buying when the price breaks and closes above the resistance. Again, there’s the risk of false breakouts.

Retest Entry: After breaking resistance, wait for the price to pull back and retest the new support level (former resistance) before bouncing back up. This retest can be a more conservative entry point for long positions.

For breaks to be deemed valid, many traders look for:

• Volume Confirmation: A significant increase in volume during the break can validate it, suggesting a strong conviction behind the move.
• Close Confirmation: A candlestick or bar that closes beyond the support or resistance level can be a more reliable indication than just an intraday penetration.

False Breakouts

An essential aspect to consider is the occurrence of false breakouts. These happen when the price appears to break through a support or resistance level but then quickly reverses direction. False breakouts can trap unsuspecting traders, making it crucial to await confirmations before committing to a trade based on a perceived break.

Is Supply and Demand the Same as Support and Resistance?

Supply and demand and support and resistance are related concepts in technical analysis, but they are different. Each has distinct characteristics and interpretations. Let’s break down the differences and relationships between the two:

Supply and Demand

Supply and demand are fundamental economic principles that describe the relationship between the availability of a good and the desire for that good. When demand exceeds supply, prices tend to rise, and when supply exceeds demand, prices tend to fall.

Zones

In trading, areas on a chart where buying interest (demand) outstrips selling interest (supply) are termed “demand zones,” leading to a potential price rise. Conversely, areas where selling interest (supply) exceeds buying interest are termed “supply zones,” which may push prices down.

Cause & Effect

The creation of supply and demand zones can often be linked to significant news, earnings reports, or other external events. These zones reflect the broader market’s consensus on price value post such events.

Relationship and Differences

• Origins: While support and resistance levels are often derived from historical price data and technical tools, supply and demand zones are rooted in the broader economic principles of surplus and shortage.
• Overlap: A demand zone can act as a support level because it represents an area where buyers have historically shown strong interest. Similarly, a supply zone can act as resistance due to the historical selling interest at that level.
• Visualization: Support and resistance are typically represented by single horizontal lines on a chart, while supply and demand zones are often depicted as areas or rectangles because they encompass a range where the shift in balance occurs.
• Duration: Support and resistance levels can exist for longer periods without a major event changing them, while supply and demand zones might shift more frequently as the market re-evaluates the asset’s value based on new information.

Recommended Resources

Platforms

• TradingView
• MetaTrader 4 (MT4)/ MetaTrader 5 (MT5)

Websites & Forums

• BabyPips
• Forex Factory