Support and resistance is a fundamental concept in trading. I would suspect most of the readers of this blog have at least a basic understanding of how support and resistance works in markets.
Here is a good definition of support and resistance. What I wanted to talk about is how I use it in my trading activities.
I trade with three fundamental attributes of support and resistance:
1. For me, support and resistance are zones, not finite numbers. The greater the timeframe, the more this attribute applies. I am looking at daily charts and longer, I draw the support and resistance zone as 1/4 ATR beyond the level of support. I expect that price will begin to change direction in this area. Combined with moving averages and certain patterns, like the hammer, this has worked well.
2. Support/resistance is validated by the number of times the zone is touched. Corey at afraid to trade used this “number of times touched method” as one measure to assess the validity of trend lines. I share his conclusions. When I observe price bounce off a zone of support and resistance multiple times, I know that zone is strong. It’s my interpretation that the higher the time frame (days, weeks, months…), the more powerful the zone has become.
3. Don’t forget pivots when trading intraday. Perhaps using pivots deserve their own article. Pivots are areas of support and resistance calculated from the previous day’s high, low, open, and close. The true value in the pivot numbers is that they are widely followed. The whole concept of support and resistance is that support and resistance holds because so many traders buy or sell when price hits a certain number. This is exactly why pivots are useful from an intraday perspective. Pivot points are generally calculated the same way. So when you look at a widely traded contract like the emini S&P, price will bounce, consolidate, and break around pivot points. Here is an excellent pivot point calculator.
Hope this got you thinking about how you use support and resistance in your own trading. It’s an easy concept to understand, so it’s easy to brush off as not as important.
Support and Resistance levels are patterns of classical technical analysis. All trend (channel) lines, reversal and continuation chart patterns are only combinations of support and resistance levels.
Support level is a starting point of an uptrend, and is actually a tangent to the minimum prices. It is commonly thought that when the price falls down to the support level, Bulls (buyers) start to resist against further price decrease thus giving it support. This explains why is many cases the price will bounce back and start rising after having reached a support level.
After several attempts the price may break the support level. Once the support level is broken, it becomes the resistance level:
There is an example of when a support level became resistance in September 14, 2003:
Resistance level is a tangent to the maximum prices:
It is assumed that once the price reaches this level it will not point higher. After several attempts the price may break the resistance level. Once the resistance level is broken it becomes the support level.
Support and resistance levels are very easy to create and they are a very effective method to forecast price behaviour. In order to define if the support/resistance level breakout is true, please refer to the criteria outlined for trend lines.
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Support and resistance is one of the most widely used concepts in trading. Strangely enough, everyone seems to have their own idea on how you should measure support and resistance.
Let’s just take a look at the basics first.
Look at the diagram above. As you can see, this zigzag pattern is making its way up (bull market). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.
As the market continues up again, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time. The reverse of course is true of the downtrend.
Plotting Support and Resistance
One thing to remember is that support and resistance levels are not exact numbers. Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it. With candlestick charts, these "tests" of support and resistance are usually represented by the candlestick shadows.
Notice how the shadows of the candles tested the 2500 resistance level. At those times it seemed like the market was "breaking" resistance. However, in hindsight we can see that the market was merely testing that level.
So how do we truly know if support or resistance is broken?
There is no definite answer to this question. Some argue that a support or resistance level is broken if the market can actually close past that level. However, you will find that this is not always the case. Let's take our same example from above and see what happened when the price actually closed past the 2500 resistance level.
In this case, the price had closed twice above the 2500 resistance level but both times ended up falling back down below it. If you had believed that these were real breakouts and bought this pair, you would've been seriously hurtin! Looking at the chart now, you can visually see and come to the conclusion that the resistance was not actually broken; and that it is still very much in tact and now even stronger.
So to help you filter out these false breakouts, you should think of support and resistance more of as "zones" rather than concrete numbers. One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart. The reason is that line charts only show you the closing price while candlesticks add the extreme highs and lows to the picture. These highs and lows can be misleading because often times they are just the "knee-jerk" reactions of the market. It's like when someone is doing something really strange, but when asked about it, they simply reply, "Sorry, it's just a reflex."
When plotting support and resistance, you don't want the reflexes of the market. You only want to plot its intentional movements.
Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.
Other interesting tidbits about support and resistance:
When the market passes through resistance, that resistance now becomes support.
The more often price tests a level of resistance or support without breaking it the stronger the area of resistance or support is.
Trend Lines
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Trend lines are probably the most common form of technical analysis used today. They are probably one of the most underutilized as well.
If drawn correctly, they can be as accurate as any other method. Unfortunately, most traders don't draw them correctly or they try to make the line fit the market instead of the other way around.
In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).
Channels
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If we take this trend line theory one step further and draw a parallel line at the same angle of the uptrend or downtrend, we will have created a channel.
To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to position where it touches the most recent peak. This should be done at the same time you create the trend line.
To create a down (descending) channel, simple draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley. This should be done at the same time you created the trend line.
When prices hit the bottom trend line this may be used as a buying area. When prices hit the upper trend line this may be used as a selling area.
Summary
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When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.
As the market continues up again, the lowest point reached before it started back is now support.
In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys). In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).
To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to position where it touches the most recent peak.
To create a down (descending) channel, simple draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley.
I am in my mid-forties, an IT professional graduated with BE degree. Career-wise I am in mid-level management role working in a fulfilling job with some traveling in Asian region and some free time available to pursue other interests. I have been trading Forex for the past 4 years. So far, I have busted 2 trading accounts and wipe out $40K SGD. This blog is a record of a renew journey in trading Forex.
(4 Dec 2008)
