Support and Resistance

 

Support and Resistance are the most popular concept in technical analysis method. Simply, support level is a level below that price is difficult to go under through; and resistance level is a level above that price is difficult to go over through. Support and resistance level are drawn by a horizontal line. Let imagine that support and resistance levels are like the floor and the ceiling of a room, then the price is like a ball that rebound between them.

support resistance

Support level is created when there are a lot of buyers enter the market make the demand increased thus prevent the price from falling lower. In contrast, resistance level is created when there are a lot of sellers enter the market make the suppy increased thus prevent the price from rising higher.

 

How to define support and resistance levels correctly?

 

The support or resistance level is defined by at least two tops or bottoms of the price in the chart. But this level is not necessary to be at an exact value. Actually, this level is a relative band instead of a perfect line. There must be a question in your mind: "How thin is this band?". Well, like its relativity, there is no exact value for its dimension. The width of this band depends on which timeframe you are using and how is the volatility of the price.

 

support resistance level

 

Will support and resistance level hold forever?

 

If price will surely rebound one it touchs the support or resistance level, trading forex seems to be so easy, huh? Unfortunately, they are broken as usually as they are made. When a support or resistance is formed, price tends to test it several times before break it out. The word "Test" here means price touchs the level but fail in breaking it then back off, which presents on chart by shadows of candlesticks. So, how strong or weak are these levels? Here are the tips:

 

- The more times the support and resistance levels are tested, the stronger the support and resistance levels.

 

- The firmer price rebounces from the support and resistance levels, the stronger the support and resistance levels.

 

- The longer timeframe the support and resistance levels are formed in, the stronger the support and resistance levels.

 

Look at figures below for example:

support

 

The more times the support and resistance levels are tested, the stronger the support and resistance levels

 

 

support

The less times the support and resistance levels are tested, the weaker the support and resistance levels

 

resistance

The firmer price rebounces from the support and resistance levels, the stronger the support and resistance levels

 

resistance

The more hesitative price rebounces from the support and resistance levels, the weaker the support and resistance levels

 

Role Reversal

 

Once a support or resistance level is broken, the roles of the resistance and support reverse. If the price goes below a support level, that support level will tend to become a new resistance level. Conversely, if the price goes above a resistance level, that resistance will tend to become a new support level.

support resistance role reversal

Broken resistance becomes new support

Other Tips

 

The stronger the support and resistance levels, the farther price can go after breaking these levels. Support and resistence levels are like the front line in a battle of buyers and sellers, so the fiercer the battle the more glorious for the winners.

 

There is a phenomenon that support and resistance level may be created at rounded values of price such as 1.20000, 1.35000, 80.000, 85.000, etc., This is specially effective with major pairs, metals and indicies, which instruments are influenced by the threshold of price level in market psychology.

 

How To Trade The Support And Resistance?

 

Well, you have learned about the support and resistance levels, but how to apply these into your trading? Once price hits the trend line, there are two cases may happen: it rebounces from these levels or it breaks them. Base on that, we have two ways to trade support and resistance: trade rebounce and trade breakout. Let's move to each method.

 

Trade Rebounce

 

This method is quite simple: once the price hits the support or resistance level, it tends to rebounce, thus you should trade on the same direction of the rebounce. You should buy if it's support level and sell if it's resistance level.

trade support resistance rebounce

You can wait for the confirm candlestick closed to make sure the rebounce is valid. Using limit order with entry point at the support or resistance level is also a good idea to trade rebounce. Stop loss can be set below the touched point (for support) or above the touched point (for resistance) in order to protect yourself in the case price fail to rebounce and break the level. Take profit can be set at a suitable loss/profit ratio (e.g., 1 loss : 1 profit) or just waiting for the price to have another reverse signal again then exit the trade manually. Here is an example:

 

Trade breakout

 

This method is used when the support or resistance level is "broken-out". If you see a candlestick penetrates the support or resistance level, there may be a opportunity to trade breakout. You should trade only until this candlestick is closed at the other side of the level (this candlestick is called breakout candlestick). If it's support level, you should place sell entry; If it's resistance level, you should place a buy entry.

 

Waiting for the penetrating candlestick to closed before enter the trade to make sure you get true breakout. Stop order is another way to trade breakout, just set a triggered entry point below the support or above the resistance level. You can set a stop loss at last top (for support) or last bottom (for resistance) at the old side of the level, which is probably another resistance or support level, to avoid getting over loss in the case price can't break the trend and return. A take profit can be set at a suitable loss/profit ratio (e.g., 1 loss : 1 profit) or just waiting for the price to have another reverse signal again and exit the trade manually. Note that the stronger the support and resistance level, the further price can go after breakout. See the example below:

trade support resistance breakout

Sometime the candlestick penetrates the trend line but then back off and closed at the old side of the trend line make its shadow go through the trend line but its body still stay back. In this case, instead of breakout you will get the false breakout (also called fakeout).

 

Conclusion:

 

Well done! You have support and resistance level is the first tool in the backpack. Let's review all things in this lesson:

 

- Support or resistance level is a horizontal narrow band that contains at least two bottoms or tops of price chart.

 

- Price tends to rebounce when it hits the support or resistance level.

 

- These level will not hold forever. Broken support tends to become new resistance and vice versa.

 

- It is possible to trade rebounce with touching candlestick closed at the rebounce side or using limit order.

 

- It is possible to trade breakout with touching candlestick closed beyond the support/resistance level or using stop order.