Support and resistance are foundational concepts in technical analysis and are among the most widely used tools by traders. However, it’s important to note that these concepts are highly subjective. Different traders may have varying opinions on where the most optimal support and resistance levels are located, making it as much an art as it is a science.
Understanding Support and Resistance
At its core, support is a price level where a market in a downtrend temporarily halts its decline and often reverses direction, shifting to an uptrend. This occurs because the support level acts as a psychological “floor” where buying interest outweighs selling pressure, leading to a pause or reversal in the downward momentum.
Conversely, resistance is a price level where a market in an uptrend experiences a temporary slowdown or reversal, transitioning into a downtrend. This happens because the resistance level serves as a psychological “ceiling” where selling interest overtakes buying pressure, causing the upward momentum to stall or reverse.
Figure 1: A sketch showing support and resistance levels in a trending market.
A simple way to remember these concepts is: support acts as a floor that stops the price from falling further, while resistance acts as a ceiling that prevents the price from rising higher. Here is a real-chart example of this in an up-trending market.
Figure 2: Support and resistance levels in a real up-trending market.
Now for an example in a down-trending market.
Figure 3: Support and resistance levels in a real down-trending market.
How to Identify and Plot Support and Resistance Levels
The next logical question you might have is, “How do I accurately plot these levels?” While there are various methods, it’s crucial to remember that identifying support and resistance is not an exact science. Different traders may pinpoint different levels based on their interpretation of the market.
To plot these levels, you generally look for areas where the price has reversed direction, either from a downtrend to an uptrend (support) or from an uptrend to a downtrend (resistance). It’s important to pay attention to the shadows (wicks) of the candlesticks, as they can provide valuable insights into where the market has tested these levels.
In many instances, the market will frequently “test” your support or resistance levels, which means that the shadows of the candlesticks touch these levels without closing beyond them. This repeated testing can strengthen the validity of your levels.
However, there will be times when it appears that your levels have been broken, only for the market to revert back. This is often referred to as a false breakout or fakeout. To avoid being misled by these false breakouts, it’s helpful to think of support and resistance not as single lines but as zones.
These zones represent areas of interest rather than precise levels, allowing for some fluctuation in price. Candlestick charts can help visualize these zones, but for greater accuracy, it’s often better to plot them on a line chart. A line chart naturally filters out the market noise (shadows), providing a cleaner view of where the true support and resistance zones lie. Once plotted, you can switch back to a candlestick chart to see how these zones align with the market’s price action.
Figure 4: Support and resistance zones plotted on a line chart.
Key Concepts to Remember
- Major vs. Minor Support and Resistance:
- Major support and resistance levels are those that have been tested frequently without being broken. These levels often represent significant psychological barriers in the market.
- Minor support and resistance levels are those that have been tested less frequently. While still important, they are not as strong as major levels and can be more easily broken.
- Role Reversal:
- When a price breaks below a support level, that support often turns into resistance in the future. This is because the psychological “floor” that previously held up the price now becomes a “ceiling” that prevents the price from rising back up.
- Similarly, when a price breaks above a resistance level, that resistance can turn into support. The psychological “ceiling” that once capped the price now becomes a “floor” that supports it.
- Psychological Significance:
- Support and resistance levels often coincide with significant psychological numbers, such as round numbers (e.g., 1.3000 in Forex). These levels are watched by many traders and can become self-fulfilling prophecies as traders react to them.
- Market Context:
- Always consider the broader market context when identifying support and resistance. A level that held in a bullish market might not hold in a bearish market and vice versa. Understanding the market environment helps you gauge the strength of these levels.
- Volume and Confirmation:
- Volume can play a crucial role in confirming the strength of a support or resistance level. High volume near these levels often indicates strong interest and increases the likelihood of the level holding. Conversely, low volume can signal weakness and a higher probability of the level being broken.
Mastering the identification and application of support and resistance is a fundamental skill in trading. By understanding these concepts and applying them with the consideration of zones rather than precise lines, you can better navigate the markets, avoid common pitfalls like false breakouts, and enhance your trading strategy. Remember that while support and resistance are powerful tools, they work best in conjunction with other technical indicators and a solid understanding of market context. As you gain experience, your ability to identify and leverage these levels will become an invaluable asset in your trading toolkit.