Support and resistance are very common among traders who use technical analysis to make trading decisions.
When used properly, they can help you become a successful trader.
However, these two zones are abused and misused by many.
Due to this, some traders believe that these two lines don’t work but they are only good for a psychological help.
However, the fact is that these two lines are very useful to traders when used properly.
They can help a trader know the price levels on a chart that act as barriers, preventing the price from moving in a particular direction.
These two zones should be seen as levels at which the price is most likely to pause or change direction.
Due to this, they are very useful as far as price analysis and making trading decisions are concerned.
In this article, I will help you know why support and resistance zones work when used properly.
Let’s start…
What are Support and Resistance Levels?
Traders use the S&R levels to determine the price levels at which there is a possibility of a pause or reversal of a prevailing trend.
The support level is where a downtrend is expected to pause due to concentration of demand.
Resistance on the other hand is where an uptrend is expected to pause temporarily as a result of concentration of supply.
So, technical analysts use these two levels to determine the interactions between the forces of demand and supply in the market.
When the price breaks the support or the resistance level, the traders conclude that the demand and supply forces that created them have changed, and there is a possibility of creating new levels.
Always remember that the two levels mark price levels at which a trend is most likely to come to an end or change direction.
Also, it’s worth noting that a support or resistance level can be a price or a price area.
When it’s a price area, it means that it occupies a larger zone on the price chart.
The time frame of the trader determines the interpretation of the significance of a level.
Traders are recommended to combine these other technical indicators when using them to make trading decisions.
Examples of such technical indicators include moving averages, stochastic, etc.
However, it is possible for you to trade the S&R levels using only the price action.
The support zone is the price level where buyers join the market and become more aggressive, preventing the price from going further lower.
As the price declines towards the support, selling pressures reduce due to lower price, and buyers become more aggressive as a result of the lower price.
Eventually, the support level will be broken and the price will decline below it.
The price level will then become the future resistance level.
The resistance zone is the price level where sellers jump into the market and become more aggressive, preventing the price from going higher.
As the price moves towards the resistance, the buying pressures will decline because of the higher prices.
At the same time, the selling pressure will increase because of the higher prices.
The resistance level will finally be broken and the price will rise above it.
That price level then becomes the future support level.
Consider the chart given below…
The above chart shows the formation of the support and the resistance lines on the price chart of a forex pair.
The support is the blue line running horizontally and marked as Support.
The resistance is the red line running horizontally and marked as Resistance.
The two lines enclose a price area commonly known as a Range.
The range is formed when the price of a security keeps on moving up and down within two levels.
The chart shows that the price tries to break out upwards through the resistance severally.
However, this did not happen.
This is the time when the bulls are controlling the market.
Their buying activities in the market led to the rise in the price of the pair, creating bullish moves.
As the price of the forex pair kept on increasing, the buying pressure reduced because of the higher prices.
However, the sellers quickly joined the market and became more aggressive, pushing the price of the forex pair lower.
Remember that the sellers were attracted into the market by the higher prices of the forex pair.
This led to the formation of the resistance line.
The chart also shows that the price tried to break through the support line downwards severally.
However, this did not happen.
This is the time when bears where controlling the market.
Their selling activities in the market led to the formation of a bearish move in the market.
However, the price of the forex pair kept on reducing and the selling pressure reduced.
Buyers were attracted by the lower prices of the forex pair, hence they jumped into the market to buy it.
The buying activities of the buyers begun to push the price higher, and this led to the formation of the support line.
Support and Resistance Role Reversal
When doing technical analysis, you will realize that the role of support or resistance changes after it has been broken by the price.
Once the price action breaks through a support line, the support line becomes a resistance line.
The vice versa is also true, that when the price action breaks through a resistance line, the resistance line becomes a support line.
You may ask yourself…
But why?
Remember we said that the S&R levels are formed as a result of the interaction between the forces of demand and supply in the market.
So, when the price action manages to move past a support or resistance level, it acts as an indication that the demand or supply has changed.
Consequently, the role of the support or the resistance line also changes.
Consider the price chart given below…
The above chart shows a support line changing its role to a resistance line.
The support line has been shown by a green horizontal line pointed to by a black arrow marked as Prior Support.
At this time, the sellers are controlling the market.
The price severally attempts to break downwards through the support line unsuccessfully.
This is caused by the selling activities of the sellers in the market.
The price of the forex pair went lower, reducing the selling pressure
The buyers were then attracted to the market to buy the forex pair at the lower prices.
The buying activities of the buyers caused the price of the forex pair to move higher.
That’s how the support line was formed.
However, the sellers finally managed to overpower the buyers, causing the price action to break downwards through the support line.
The role of the support line changed immediately after the occurrence of this breakout.
The prior support line has become a resistance line.
The buyers kept on pushing the price of the forex pair upwards.
However, the sellers kept on pushing the price of the forex pair downwards.
That’s why the price action keeps on hitting the resistance line and bouncing off it.
This led to the formation of the resistance line as shown on the chart.
Consider the chart given below…
The above chart shows a typical example of a resistance line turning out to become a support line.
During the formation of the resistance line, the bulls are controlling the market.
The buying activities of the bulls in the market led to an increase in the price of the forex pair.
That’s why the price kept on hitting the resistance line.
However, the bears joined the market and pushed the price of the forex pair lower.
The bears were attracted to the market by the higher prices of the forex pair, which also reduced the buying pressure.
That’s how the resistance line was formed.
Finally, the bulls managed to overpower the bears, causing the price to break through the resistance line upwards.
The role of the resistance line changed immediately after the occurrence of the breakout.
It began to play the role of a support line.
The bears keep on pushing the price of the forex pair lower, but it bounced off the support line.
Steps for Choosing S&R Tools
As a trader, you should know the tools that will help you identify the S&R levels on your price charts.
The good news is that there are different tools that you can choose and use for this.
When choosing the tool to use, follow the steps given below…
Step 1: Trying phase- You should begin by trying all the S&R tools that you know.
There is no limit in terms of the number of S&R tools that you can try.
The purpose of trying is to identify the tools that might seem suitable to you.
Write down the ones that seem to work well for you.
Step 2: Research the tools- At this point, you have created a list of the tools that seem to work well for you.
However, you don’t know much about the tools.
Hence, it is time for you to do a research about them and get an in-depth knowledge about the tools.
Do adequate research to familiarize yourself with all the rules behind each of them.
Also, make sure that you know all the assumptions behind each tool.
Step 3: Test the tools- In the previous steps, you should have narrowed the list of tools that seem to work well for you.
It is now time for you to practice using each of these tools.
Ensure that you know the methods that seem to work well with each of the tools.
This will help you know how to use each tool in depth.
Step 4: Make a decision- At this point, you know much about the various S&R tools.
You can now select the S&R tool/s that fits your trading psychology, trading strategy, and your allowed time.
This step will depend on your findings from the previous steps.
Step 5: Integrate the tool – You are now sure of the best tool that will help you identify the S&R levels.
You can now integrate it into your trading plan.
You will then find it easy to spot the S&R areas on your chart and increase your chances of becoming a successful trader.
Plotting Support and Resistance Levels
For you to use the S&R levels properly, you have to plot them correctly.
This means identifying the levels on your price chart where the price is most likely to reverse or where a trend is most likely to come to a halt.
Consequently, if you plot the S&R levels wrongly, you will end up making wrong trading decisions.
This can lead to failed trades.
Luckily, there are different tools that you can use to identify the positions of these two zones.
Each trader will have his own preference when it comes to the choice of the S&R tools.
Some traders may prefer to use only Fibonacci levels, while others will choose to mix pivot points and moving averages.
There is no correct answer as far as selection of the tools to use is concerned
The best way to approach it is to identify the tool or tools that work well for your trading psychology as well as with your trading system and method.
Since the preferences are subjective, it will be good for you to test the different S&R tools for a few days or weeks.
Just because an S&R tool works well for a certain trader doesn’t mean that it will work well for you.
Here are the different tools that you can use to plot S&R levels…
#1: Using Trend-lines
The S&R levels are highlighted using angled or horizontal lines known as trendlines.
If the price pauses and reverses in the same area for two different occasions in succession, you can draw a horizontal line that shows that the price is struggling to move past that area.
If the price is in an uptrend, it will create higher highs and higher lows.
If the price is in a downtrend, it will create lower lows and lower highs.
You should connect the highs and the lows during the trend.
You can then extend that line to the right to see where it can find support and resistance in the future.
An uptrend can act as a support, while a downtrend can act as a resistance.
Normally, the price moves above an uptrend, hence, the uptrend can be used as a support.
Also, price tends to move below a downtrend, hence, the downtrend can be used as a resistance.
Consider the chart given below…
The above chart shows an uptrend line drawn on the price chart of a forex pair.
The uptrend line is the black line added on the chart and pointed to by a black arrow.
The section where the uptrend line has been drawn shows that the price of the forex pair is in a bullish trend.
The chart shows that the price tried to break through the trend line downwards many times.
This is very clear as shown by the swing lows that were formed during the bullish move.
However, the price kept on bouncing off this line.
Hence, the uptrend line is acting like a support line.
However, the price finally managed to break out through the uptrend line downwards as shown on the chart.
The uptrend was formed at a time when the bears were trying to overpower the bulls.
The breakout to the downwards is an indication that the bears have managed to overpower the bulls.
Consider the chart given below…
The above chart shows a downtrend line added on the price chart of a forex pair.
The downtrend line is the red line pointed to by a black arrow on the chart.
The chart shows that price of the forex pair is in a bearish trend during the time of the downtrend line.
The price tries to break through the trend line upwards severally.
This is the action of the bulls in the market, but the bears join the market at the position of the downtrend line and push the price of the forex pair lower.
So, the price bounces off the line and makes a retracement.
Hence, the downtrend line is acting like a resistance line.
If you consider the two trend line charts given above, you will realize that I relied on more than two points to draw the trend lines.
It is recommended that you use two or more peaks for a downtrend or two or more bottoms for an uptrend.
If you draw such a trend line, you will get a tentative trend line.
It will be good for you to rely on three or more peaks for a downtrend line or three or more bottoms for an uptrend line.
This way, you will get a valid trend line.
So, a high number of points for a trend line will give you a more valid and confirmed trend line, which is better.
When the price action is in a Range, or a sideways movement, it creates very strong support and resistance lines.
When ranging, the price moves in between two horizontal lines.
The price hits the upper line and bounces off it, it hits the upper line and bounces off it.
This sequence may continue for some time, and the trader doesn’t know the direction that the price will take after the range comes to an end.
The upper line of the Range is the resistance line, while the lower line of the range is the support line.
#2: Using Tops and Bottoms
The price of a forex pair must make swings from time to time.
The price swings will lead to the formation of swing highs and swings lows within a trend.
You can use these swings lows and swing highs to determine the S&R levels on the price chart.
When using this approach, the first step should be to identify the highest as well as the lowest points that the price action has managed to reach.
Mark the highest point as ATH (All Time High) and the lowest point as the ATL (All Time Low).
You can then mark each top and bottom formed by the price action using horizontal lines.
In a downtrend, each top should be marked as a Lower High while each bottom should be marked as a Lower Low.
In an uptrend, each top should be marked as a Higher High while each bottom should be marked as a Higher Low.
Consider the chart given below…
The above chart shows the price behavior of a forex pair forming a downtrend.
The downtrend has been shown by the red arrow running downwards and marked as Downtrend.
Horizontal lines have been used to mark each top and bottom.
Whenever the price of a forex pair is in a downtrend, each lower low acts as a support level while each lower high acts as a resistance level.
The ATH (All Time High) and the ATL (All Time Low) levels have also been marked on the chart.
The ATH is the highest level that the price action managed to reach during the downtrend.
The ATL is the lowest level that the price action managed to reach during the downtrend.
The tops and the bottoms created by the price swings have been shown using horizontal lines and marked as Lower High and Lower Low respectively.
You can also identify the S&R levels formed when the price is in an uptrend.
First, you should mark the ATH and the ATL levels, which are the highest and the lowest points reached during the uptrend respectively.
Every top formed during the uptrend should be shown using a horizontal line and marked as Higher High.
Every trough formed during the uptrend should be shown using a horizontal line and marked as Higher Low.
Each higher high will act as a resistance level while each higher low will act as a support level.
#3: Moving Averages
The moving average indicator is added on top of the price action of a forex pair chart.
The good news is that you can use this indicator to determine the S&R levels on your chart.
The moving average indicator itself acts as a support or as a resistance depending on the direction of the price.
If the price is in a downtrend, the moving average indicator acts as a resistance line.
If the price is in an uptrend, the moving average indicator acts as a support line.
You will see the price hitting the moving average indicator and bouncing off it.
Consider the chart given below…
The above chart shows the 20-period moving average added on the price chart of a forex pair.
The 20-period moving average has been pointed to by a black arrow and marked accordingly.
The price has been in a downtrend for some time.
This has been shown by the red arrow running downwards on the chart and marked as Downtrend.
The price tries to break upwards through the moving average but it fails constantly.
The prices hits the moving average but it bounces back.
From this, you can tell that the moving average is acting like a resistance line.
So, the moving average acts as a resistance line when the price is in a downtrend.
The vice versa is true when the market is in an uptrend.
In this case, the moving average acts as a support line.
The price will try to break downwards through the moving average, but it will bounce off it and fall back up.
Consider the chart given below…
The above chart shows a 15-period moving average inserted into the price chart of a forex pair.
The chart shows that the market has been in an uptrend for some time.
This has been shown by the black arrow running upwards and marked as Uptrend.
The price hits the moving average severally, attempting to break downwards through it.
However, it bounces off it and moves upwards.
This shows that the moving average is acting like a support line.
So, when the market is in an uptrend, the moving average indicator plays the role of a support line.
Such type of support is referred to as a dynamic support because the level changes every time the moving average makes a move.
In our previous chart, we used a 20-period moving average but in this case, we have used a 15-period moving average.
However, remember that you can use any period for the moving average to determine the S&R levels.
The moving average indicator can be used with different periods.
You also have the opportunity of using either the simple or the exponential moving average.
#4: Fibonacci Retracement and Extension Levels
The Fibonacci numbers are found in nature and forex traders have established clever ways of using them to find S&R levels.
The most popular Fibonacci levels include 23.6%, 38.2%, and 61.8%.
Since you can draw the Fibonacci levels depending on the low and the high of a major price swing, these mostly act as major pivot zones that traders can use to predict the end of a retracement or an area where the market may resume a prevailing trend.
Once the price has made a major move, may it be upwards or downwards, it will often make a significant retracement of the original move.
During the formation of the price retracement, the support or resistance levels will be formed at or near the Fibonacci retracement levels.
If the price is in an uptrend, mark the Fibonacci retracement levels from ATL to ATH.
The price will make an upward move and then retrace back.
The support level is where the price rests for some time.
Also, once the ATH has been penetrated, it can be used as a support level.
If the market is in a downtrend, the Fibonacci retracement levels should be marked from ATH to ATL.
The market will make a downward move and then make a retracement.
The retraced price will reach the Fibonacci levels, which can be used as the resistance levels.
How to Trade based on Support and Resistance Levels
Once you have mastered S&R levels well, you can use them to make your trading decisions like when to enter, when to exit, where to set your stop loss, where to place your profit target, etc.
The basic approach when using these two levels is to buy near support when the market is in an uptrend or the parts of ranges or chart patterns when the price is moving up and sell near resistance in downtrends or the parts of ranges and chart patterns when the price is moving downwards.
This will help you to isolate a longer-term trend, even when you are trading a range or a chart pattern.
The Entry Point
The trend should guide you on the direction that you should trade in.
For example, if the market is in a downtrend and then a range is formed, you should consider going short at range resistance rather than buying at range support.
The reason is that a downtrend is a signal that you stand better chances of making profit by going short than going long.
If the market is in an uptrend and then a triangle pattern forms, you should consider buying at the support of the triangle pattern.
Consider the chart given below…
The above chart shows the formation of a strong support line.
This has been shown by the black horizontal line on the bottom part of the chart and marked as Strong Support.
The chart shows a strong downtrend developing, and this sends a strong sell signal.
You can enter a short trade at the position pointed by a black arrow and marked as Possible Short Trade.
A closer look at the chart reveals that the price maintained a bearish move from that position, and this bearish move continued for some time.
If you had entered a short position, you will make a profit from the price drop.
However, the price suddenly encountered the support line.
It is after this that the price begun to make a sideways movement, forming something like a Range.
This is a signal that the support line is very strong.
Remember that a support line acts as a signal that the price action is most likely to change from a bearish to a bullish trend.
That’s why you must always be keen about going short near resistance lines.
The price managed to break out through the strong support.
This is the location where the lower wick of the bearish/red candle managed to cut through the strong support line.
However, this was a false breakout because it was followed by a very strong bullish move.
This means that the price is respecting a very strong support area.
Anytime the price breaks higher after reaching a strong support, an uptrend is most likely to occur.
That is exactly what has happened in the above chart.
So, it will be wise for you as a trader to buy near support or sell near resistance.
However, you are not assured that the support or resistance will hold.
Hence, it will be good for you to wait and receive a confirmation that the price will respect that area.
If you want to buy near support, wait for a consolidation to be formed near the support area, and then buy the forex pair when the price breaks the high of that consolidation area.
If the price shows that behavior, it means that it is respecting the support area and that the price is about to move higher off the support.
You should follow the same concept when selling at the support line.
You should wait for the price to form a consolidation around the resistance line, then enter a short position after the price drops below the low of the consolidation period.
Consider the chart given below…
The above chart shows the price of a forex pair consolidating at the resistance line and the position at which you should enter a short trade.
First, the market is in an uptrend.
This has been shown by the black line running upwards and marked as Uptrend.
After the uptrend hit the resistance, which is the red line running horizontally at the top of the chart, it begun to make a consolidation.
A closer look at the price action during this period shows that it is forming something close to a range.
The price is trying to breakout upwards through the resistance line, but it did not succeed.
Finally, a strong bearish move developed in the marked as shown by the sequence of the strong bearish candles.
The best time to enter the market has been pointed to by the red arrow marked as Go Short.
This is the position at which the price manages to drop below the low of the consolidation period.
A closer look at the price behavior after the entry point shows that the market maintained the bearish move for some time.
If you had entered a short position at the marked point, you will make profit from the bearish move.
Setting the Stop Loss
After entering a trade, you are not certain that the market will keep on moving in the current direction.
Forex is a very dynamic market and things can change anytime.
So, you must ensure that your trade is protected.
The best way to protect your trade is by setting a stop loss.
This will help you exit the trade automatically the moment the market begins to move against you.
But when trading the S&R levels, where should you place the stop loss?
Let me show you…
If you are buying, place the stop loss several pips below the support line.
On the other hand, if you are selling, place the stop loss several pips above the resistance line.
You don’t need the stop loss to be triggered unnecessarily, especially when a consolidation period occurs in the market.
If triggered unnecessarily, the stop loss can make you exit the trade prematurely, meaning that you will miss out on making some profits.
So, make sure that the stop loss is placed few pips below the consolidation when buying and few pips above the consolidation when selling.
See the chart given below…
In the above chart, the trader should sell the forex pair at the position marked as Go Short.
Other than entering a short position, the trader should protect his trade using a stop loss.
The position of the stop loss has been shown by a small red horizontal line marked as Stop Loss.
If the price makes a reversal and begins to move upwards, the stop loss order will be triggered, and you will automatically exit the trade.
This will prevent you from incurring a loss.
A closer look at the position of the stop loss reveals that it was placed some pips above the consolidation period.
This means that the stop loss will not be triggered unnecessarily, which can make you exit the trade when it’s too early.
It also means that you will not miss out on making profits.
Profit Target
When entering any trade, you must have a target price for a profitable exit in your mind.
If you buy the forex pair near the support line, ensure that you exit the trade before the price hits a strong resistance line.
If you enter a short position at resistance, just exit the short position before the price hits a strong support level.
It will also be good for you to exit at minor support and resistance levels.
For example, if the price is in a rising trend channel and you buy at support, it will be good for you to sell at the top of the channel.
Sometimes, it will be better if you wait for a breakout to occur before you can exit the trade.
This way, you will make more profit compared to selling at minor support or resistance.
A good example is when you buy near a triangle support when the price is in a larger uptrend.
You can choose to hold the trade until it breaks through the triangle resistance and it continues with the uptrend.
An old support line may also become a resistance line, and an old resistance line may also become a support line.
However, this concept does not work well in some conditions like a second chance breakout.
False Breakouts
The price of a forex pair will always move further than you would expect it to.
However, this does not happen all the time, and in case it happens, it is referred to as a false breakout.
For example, if your price chart shows that the support level is located at the price $12, there is a possibility that the price will drop through $12, to $11.97, $11.89, or $11.87, and then begin to rally again.
Always remember that support can be a price or a price area.
This is also the case with resistance.
If it’s a price, the price may not go further beyond it.
However, if it’s a price area, give room for the price to go further.
False breakouts create excellent trading opportunities for traders.
One of the strategies to trade a false breakout is by waiting for the false breakout to occur, then enter the market once the breakout has occurred.
For example, if the market is in an upward trend and the price is pulling back to support, just wait for the price to break below the support and buy when the price begins to rally back above support.
If the market is in a downtrend, and the price is pulling back to resistance, allow the price to break above the resistance then enter a short position immediately the price begins to move below the resistance.
However, this approach has a downtrend in that a false breakouts will not always occur.
If you choose to wait for one, it means that you may miss on good trading opportunities.
This means that it will be good and safe for you to take any trading opportunities that present themselves.
If you manage to catch the odd false breakout trade, that will be a bonus to you.
Since false breakouts happen on occasion, it will be good for you to place the stop loss some distance from the support or resistance.
This will make sure that the false breakout is not most likely to hit the stop loss position before moving in your desired direction.
Adapting Trading Decisions to New Support and Resistance Levels
Since S&R levels are dynamic, your trading decisions that rely on them should also be dynamic.
This means that you give room to adjust your trading decisions according to the dynamic nature of these two zones.
For a market that is in an uptrend, the last high and the last low are very important.
If the price forms a lower low, it’s sending a signal that there is the potential of a trend change, but if it creates a new high, it is confirming an uptrend.
Keep your focus on the S&R levels that matter currently.
Price trends will normally encounter problems at strong areas.
Although the price may finally manage to break through, it will take time and multiple attempts.
Mark the major S&R levels on your chart since they may become relevant again if the price approaches them.
Once they are no longer relevant, delete them.
For example, when the price breaks through a strong resistance or support area and keeps on moving well beyond it.
Also, take time to mark the current and relevant resistance and support areas on your chart.
You can use them to analyze the current ranges, trends, and chart patterns.
Such minor levels tend to lose their relevance quickly as new minor resistance and support areas are formed.
Continue drawing the new resistance and support areas then delete the resistance and support that no longer hold relevance because the price has already broken through them.
For day traders, it will be good for you to focus on the current moment rather than trying to find were resistance and support lines were in the previous days.
If you look for too much information, you will experience information overload.
This is an enemy to forex traders.
If you are just beginning trading S&R levels, work on isolating ranges, trends, support, resistance, and chart patterns in a demo account.
Next, practice running trades with stop losses and profit targets.
Once you become consistently profitable with your S&R trading method, you can consider trading real money.
Conclusion:
This is what you’ve learned in this article…
- The S&R levels are very important to all traders.
- They can guide them when it comes to making trading decisions.
- The two represent price levels on the chart where the price is likely to pause or change direction.
- The S&R levels are formed as a result of interactions between the forces of demand and supply in the market.
- When price breaks through the S&R levels, the demand and supply are considered to have changed.
- The resistance is formed when the bulls are trying to push the price of the forex pair higher but the bears join the market and become more aggressive, pushing the price of the forex pair lower.
- The support line is formed when the bears are trying to push the price of the forex pair lower, but the buyers join the market and become more aggressive, pushing the price of the forex pair higher.
- To trade the S&R levels, you must learn how to identify them on your price charts.
- The good thing is that there are different tools that you can use to identify the positions of these levels on your price chart.
- Practice how to use the different S&R tools and choose the ones that seem to work well for you.
- When trading the S&R levels, consider selling at the resistance line and buying at the support line.
- When selling, place a stop loss few pips above the resistance line.
- When selling, place a stop loss few pips below the support line.
- Consider taking your profits before the price action hits a strong support or resistance line.
- In most cases, when the price action hits a strong support or resistance line, a consolidation period occurs which is followed by a reversal in the direction of the price.