In the previous articles, we discussed what support and resistance levels are, how to identify them, and how to properly draw them.
In this article, we’ll discuss how you can use support and resistance levels to find good trade setups in different market conditions.
The different types of market conditions
To understand how the market works and be able to trade properly, you should know the three recognized market conditions, which are:
- An up-trending market
- A down-trending market
- A range-bound market
An up-trending market
In this state of the market, buyers are in control, and it is characterized by higher swing highs and higher swing lows.
Take a look at the chart below:
You can see that the market is making higher swing lows, as evidenced by the up-sloping trend line attached across the swing lows.
This shows that buyers are dominating, as they are able to push the market higher.
A down-trending market
A down-trending market is characterized by lower swing lows and lower swing highs. In this market condition, sellers are in control.
Take a look at the chart below:
You can see that the market is making lower swing highs, as evidenced by the down-sloping trend line attached across the swing highs.
This shows that sellers are dominating, as they are able to drag the market down.
A range-bound market
In this condition of the market, buyers and sellers balance each other out. The market moves sideways as no group dominates for a long time.
Take a look at the chart below:
You can see that the market is moving sideways between the upper and lower boundaries of the range. This shows that neither the buyers nor the sellers are dominating.
How to trade the various markets
To trade properly and profitably, you should be able to identify the condition of the market whenever you open your chart. You must know whether the market is trending upward, downward, or sideways.
This is very important, as it will help you to know who is dominating the market and how you should trade.
If buyers are dominating, you look for buy setups at the right level, and if sellers are dominating, you look for sell setups at the right moment.
Let’s take a look at how you can use support and resistance levels to trade the various market conditions.
How to identify trading setups in an up-trending market
As I said earlier, in an up-trending market, buyers are dominating the market. Their trading activities leaves these two characteristic waves on the price chart, which you must be able to identify:
- Upward impulse swings, which signify their buying activities (entering long trades)
- Downward retracement swings (pullbacks), which signify that they are taking profits (exiting their trades).
These are the trademark waves in an up-trending market. See the labeled chart of the up-trending market below:
You can see how buyers push the market up when they are buying, creating the upswings, and when they’re taking their profits, the market makes downswings.
As a result, the chart has a series of impulse and retracement swings.
It’s clear that if you can enter with the buyers at the end of the retracement moves (or beginning of the impulse moves), you can ride the impulse swings with them and make profits.
But the question is, how do you identify the transition from the end of a retracement move to the beginning of an impulsive move?
If you can solve this puzzle, you will be able to buy at the beginning of the impulsive move and exit at the onset of a retracement move, just like the buyers.
Many naive traders often enter the market at the wrong time — when the impulsive move is already underway and almost nearing the end — and end up getting trapped in a retracement move.
However, if you understand the principles of support and resistance levels and how they change polarity when the price breaks above any level, you can use it to anticipate where and when to enter at the beginning of an impulse move.
Take a look at the chart below:
You can see how buyers are riding the market upward. Notice that the impulsive moves start from support levels (that were previously resistance levels) and end at new resistance levels higher up, while the retracement moves start from resistance levels and end at support levels.
So, those levels are the reference point.
Buyers enter at support levels and exit at resistance levels. But you don’t just place your trade at a support level.
You must confirm that buyers are willing to start a new impulse move at that level.
You can use bullish reversal candlestick patterns, such as the hammer (bullish pin bar), dragonfly doji, bullish engulfing bar, etc., for your confirmation.
See the chart below:
You can see those bullish reversal candlestick patterns at the support level, which show that buyers are ready to push the market higher.
How to identify trading setups in a down-trending market
As I stated earlier, in a down-trending market, sellers are dominating the market, so it’s best to trade in their direction.
Owing to the trading activities of sellers, a down-trending market shows two characteristic waves on the price chart:
- Downward impulse swings, which signify that sellers making short trades
- Upward retracement swings (pullbacks), which signify that sellers are taking profits (exiting their trades).
You must be able to identify these trademark waves in a down-trending market to be able to trade properly.
See the labeled chart of the down-trending market below:
You can see that each downward impulse swing is followed by an upward retracement move.
Thus, knowing how to identify the beginning of these downward impulse moves to ride them is key to making money in a down-trending market.
In a downtrend, impulse moves always start from the resistance level (which were previously support levels before the price broke below them) and end at new support levels lower down.
On the other hand, retracement moves start from support levels and rally to resistance levels.
The key to properly trading the impulse swings in a downtrend is to wait for the retracement move to reach the resistance level and then look for a trade setup there.
See the chart below:
Notice that once the market approaches the resistance level, sellers push the price down, leading to a new impulse swing downward.
So, you look for the emergence of a new impulse at the resistance levels
However, you don’t just place your trade at a resistance level. You must use a candlestick pattern to confirm that sellers are willing to start a new impulse move from there.
On that chart, our first labeled impulse swing started with a long-tailed candlestick that was rejected from the resistance level.
You can also see that the second impulsive move started with a long-tailed bar that was strongly rejected at a resistance level too.
To learn more about trading the different trends with support and resistance levels and candlestick patterns, join my trading course!
How to identify trading setups in a range-bound market
So far, we have learned that if the market is trending upward, buyers are dominating, and it’s best to look for buy opportunities.
On the other hand, if the market is in a downtrend, sellers are dominating, so you should look to short the market.
But what do you do when the market is in equilibrium and neither buyers nor sellers are dominating? This is the case in a range-bound market where the price bounces up and down between a specific upper and lower price level.
The upper level becomes a key resistance level that the price finds difficult to break above, while the lower level becomes a major support level that the price finds hard to break below.
See the chart below:
You can see that the price is moving horizontally between the support and resistance levels, implying that neither buyers nor sellers are persistently in control.
The best places to look for trade setups in a range-bound market are at the upper and lower boundaries so that you can ride each swing to the opposite end.
See the chart below:
Notice that once the price falls to the support level, it gets rejected by buyers, and the price starts an upswing.
Also, once the price reaches the resistance level, sellers defend that level and push the price back down.
So, the best way to trade such a market is to wait for a reliable price action setup to form at either the support level or the resistance level. Don’t ever trade a range-bound market midway.
Final words
From our discussion so far, you should be able to differentiate between an up-trending market, a down-trending market, and a range-bound market.
You should be able to know who is dominating the market when you see a price chart, identify the impulse and retracement swings on the chart, and spot the resistance/support levels when they begin and end.
However, these are only the basics. There is a lot to mastering how the market works and knowing when to enter and exit a trade profitably using the support/resistance levels in different market conditions. To learn how to make money in each market condition, Join My Trading Course!