Support and resistance is one of the most important technical analysis concepts. It is used by almost all technical traders in some form during trading. There is no one specific support and resistance indicator but many indicators such as Pivot points , moving averages etc. are used as support and resistance indicators.
Support and resistance are areas on chart where price has reacted in the past and may again react in future. These are areas where something interesting may happen and may give traders opportunity to trade. Support and resistance indicator helps to identify these areas in advance.
What is support and resistance indicator ?
Indicators that provide the traders with possible support and resistance areas on chart are known as support and resistance indicators. These can be static or dynamic in nature. Support and resistance indicators are derived from the price itself and are lagging in nature but can provide possible support and resistance levels of future by extrapolation.
Which are some of the popular support and resistance indicators ?
These are some popular support and resistance indicators.
- Moving averages
- Trend lines
- Fibonacci levels
- Pivot points
- RSI ( Relative Strength Index )key levels
Moving average as support and resistance indicator
Moving averages are used as dynamic support and resistance levels in trading. Dynamic because they are not horizontal lines plotted on chart and they change with change in price.
Depending upon the trend a different value of moving average can be used as support and resistance. Popular levels are 9 period , 20 period , 50 and 200 period moving averages.
9 and 20 period moving averages act as short term support /resistance. These also work very well in strong trending markets where retracements are shallow.
50 period is by far the most common moving average used in trading. It is often used as support and resistance level by swing traders. A 200 period moving average is used as support and resistance by long term investors or position traders.
Moving averages are like a self fulfilling prophecies. There are many traders which are looking at these same levels on chart and they generally react to it in similar fashion making these work. Moving averages are derived from the price itself and hence are lagging indicators in nature. These cannot be extrapolated in a normal trading situation.
However these work really well in trending market. Buying a stok in strong uptrend at 9 EMA or 20 EMA support level can give some quick gains for a swing trader.
Similarly short selling a stock in strong downtrend when it pulls back to 50 EMA/SMA can be a very good risk to reward ratio trade.
50 and 200 period moving averages are considered to be very important by many types of traders and hence they generally work better than others.
Trendlines as support and resistance indicator
Trendlines are also used as support and resistance. They are one of the most underrated tools in technical analysis.
Below you can see a trendlines acting as support and also as resistance. The line below the price acts as support. The line above the price acts as resistance.
A stock in a uptrend will make higher highs and higher lows. A trader can connect all the lower lows to plot a trendline which can be used as a support. Price approaching these trendlines in future may react and bounce in the prevalent uptrend giving trading opportunity to the trader.
As with any other support or resistance level, more times the price reacts to this dynamic level i.e trendline , more is the significance of the same.
A combination of short term and long term trendlines can be used to take a trade at support and resistance levels.
Lets take a look at this example. In the below figure we see a previous resistance level which has now become a support. The long term trend line also coincides with this to form a confluence of support levels.
The long term trend is bullish and short term trend is bearish. The short term trend line is acting as a short term resistance. Once this resistance is broken and price bounces off the long term support we can be fairly sure that the price will continue to move up and that’s exactly what happens.
Thus a confluence of support and resistance indicators can be used to take successful trade entries.
Fibonacci levels as support and resistance indicator
Fibonacci series of numbers are a series of important ratios. They appear in nature everywhere and are considered important by many traders when plotted on charts.
One can use a Fibonacci tool to plot these levels on a chart by selecting the low and high levels. The tool will plot the important intermediate levels. These are 23.6% , 38.2 % , 50% , 61.8 % and 100 %.
Best support and resistance zones appear between 50 and 61.8 %. A shallow retracement will generally find support at 263.6 or 38.2 %.
Fibonacci levels when used in conjunction with standard support or resistance lines give an edge to the trader. In the example below a previous resistance has now become support and is also coming in the important Fibonacci range of 50 / 61.8 %. The price finds support , reacts to these levels and zooms upward.
Fibonacci levels alone may or may not give you the best results but confluence of Fibonacci levels with trendlines or moving averages or with standard support and resistance levels works really well.
Pivot points as support and resistance indicator
In financial markets, a pivot point is a price level that is used by traders as a possible indicator of market movement. A pivot point is calculated as an average of significant prices (high, low, close) from the performance of a market in the prior trading period.
Pivot Points use the prior period’s high, low and close to estimate future support and resistance levels. In this regard, Pivot Points are predictive or leading indicators. There are at least five different versions of Pivot Points.
The indicator typically includes four additional levels: S1, S2, R1, and R2. These stand for support one and two, and resistance one and two.
The main reason pivot points and support and resistance levels plotted based on pivot is a lot of people are watching these same levels on chart.
Most technical traders use pivot levels as support and resistance and hence it kind of becomes a self fulfilling prophecy.
Key RSI levels as support and resistance indicator
The Relative Strength Index (RSI) is one of the most popular momentum oscillators used by traders. It is so popular that every charting software package and professional trading system anywhere in the world has it as one of its primary indicators.
RSI is one of our most favorite indicator and it provides interpretative information on market tops and bottoms, chart formations, market reversals, areas of support/resistance, and price/indicator divergence.
RS = Average of ‘N’ day’s closes UP/Average of ‘N’ day’s closes DOWN
The actual RSI value is calculated by indexing the indicator to 100 through the use of the following formula:
RSI = 100 – (100 /1 + RS)
Since this is a post on support and resistance we will not go into details on RSI. Just to give you an idea RSI levels of 40 and 60 act as support and resistance. This is mainly because of the up vs down ratio at these levels.
A price in an uptrend will cross RSI 60 and go to higher level. As it moves higher the change in RSI becomes less and less. The price comes down and so the RSI. A shallow retracement will take support at 60 level while a deep retracement will take support at level 40. The trend is still uptrend as long as price is above RSI 40 level and one should be looking for long positions only.
In above example the price is in overall uptrend. In the first part of the day price moves up. Price then comes down and finds support at RSI 60 Level. Price moves up again.
Again a confluence of standard support and resistance level and RSI key levels used together can lead to successful trade.
Later in the day price makes a dip again , this time the retracement is deeper. However price finds support at same support level and RSI 40 Level. Since price does not break RSI 40 level , we are still bullish and can take a long position.
VWAP as intraday support and resistance indicator
VWAP i.e volume weighted average price is one of the most important intraday support and resistance levels. VWAP is an indicator which is calculated by using the volume and price together and is generally used by large institutions as a fair price for the asset under trading.
Large financial institutions generally use VWAP as buy and sell points and hence it generally works as an intraday support or resistance.
VWAP used along with any of the other support and resistance indicators above can give a very good entry point to the trader.
To summarize support and resistance indicators are an essential part of a traders arsenal. These indicators provide critical areas on chart where the price can react to give trader an edge in the market. Some of the indicators are static in nature and some are dynamic in nature. Both can be used in trading to good effect once you know how to use them.