Support and resistance is one of the most important concepts in technical analysis. It is used to find the right locations on the chart where a trade entry or exit can take place.
What is support and resistance ?
By definition support and resistance are price levels, where price has reacted in the past and may react again in future. The support and resistance levels represent a concentration of buying and selling activity. Support and resistance kind of provides a bounding box for technical analysis.
Without the existence of support and resistance , we have nothing but an unpredictable and random movement of price from one point to another.
This is a long post but by the end of it you will be a master of support and resistance trading. There are some key secrets of support and resistance trading which you need to understand to become a successful trader.
You can download our a free eBook Support and Resistance pdf . The support and resistance pdf book provides fundamentals of support and resistance and a trading strategy.
Support and resistance level
Support and resistance define the relative distance between the two levels: the lowest price at which sellers are willing to sell and the highest price at which buyers are willing to buy.
I always see Support and resistance as price levels where something interesting may happen. A stock in up-move may slow down near a resistance or may move a lot faster if it breaks through the resistance. Either way , it gives us a trading opportunity.
What is Support Level ?
A support level is one where price moving down halts and reverses back. Price approaching this level tends to bounce back from this level. In below chart you can see the support levels at the bottom of the chart.
These levels provide the lower boundary to the price movement.
What is Resistance Level ?
A resistance level is the one where price moving up stops and reverses back. Price fails to go beyond this level on more than one occasions. You can see the resistance level on the top of the above chart.
This level kind of provides a ceiling to the price action.
How to find support and resistance ? ( True support and resistance)
Finding the correct or true support and resistance is an art and successful traders master this art. There are very few levels on the chart where profitable trades can be taken and true support and resistance levels give us those levels.
True support and resistance levels are those which are more relevant than others and are important for trading.
Here are some fundamental rules to identify price levels which can act as true support and resistance levels. Let’s take a look at them one by one.
- The price level should be most obvious on the chart : A true support and resistance level will always be very obvious on the chart. You will hardly need any effort to identify it. This also means a large number of traders will be looking at this level same as you. If large group of people react at same level, then you will always have good price action at that level.
- It should ideally be a swing high or swing low : A swing high or swing low is always a good support and resistance level. Price approaching these levels again in future will certainly react in some way which can give us trading opportunity.
- Price movement should generally slow down as it approaches this level , price should then face long wick rejections and then move away quickly. A quick move away is crucial and it indicates the importance of that level as large number of traders participated there.
- It should have acted as both support and resistance level. If a price level has acted as both support and resistance in the past, then it makes it interesting for us.
- The price should have multiple rejections at this level . A support or resistance level reacted by traders on more than one occasions in the past, increases its significance immensely. More the rejections the better.
- The price level should not be too far away in terms of time. A support or resistance level reacted by traders in recent past is more important than the one in the distant past. If one has to make a choice a more recent support or resistance level should be given higher importance.
- A support and resistance level facing reaction on two different timeframe charts becomes even more important as traders with different trading styles , techniques will be looking at it and price may react to it again in future.
- It should be a narrow zone : Traders always have a question if support and resistance level should be a single line on chart or it should be a zone. Our answer is; it will always be a zone. However , narrower the zone better it is. One should not mark really big zones as support and resistance levels as you will not know where exactly to trade.
You can find the right support and resistance levels on chart using above rules. Once you identify these levels , you need to plot them on chart. Lets see how to do that.
How to draw or plot support and resistance ? ( on charts)
Lets take an example of a swing trader plotting support and resistance levels on a chart. How to set support and resistance levels on chart is a question all traders wonder at the start of their trading journey.
You can follow following step by step method to to plot support and resistance level on charts.
- Step 1 : Select the timeframe you use for trading. For example a swing trader will use daily candlestick chart to identify trades.
- Step2 : Go one step higher i.e weekly timeframe in this case. Identify true support and resistance levels using rules we just learnt. Plot them with thick lines on chart.
- Step 3 : Go to the trading timeframe. i.e daily in this case. Plot support and resistance levels with a thinner line.
- Step 4 : Go to one level lower timeframe. 4 hourly in this case. Plot the support and resistance levels in very thin lines.
- Step 5 : Go to even lower timeframe. Hourly in this case. This is the timeframe that you will use to take trade entry and exits. You see all the important levels on the chart and thickness of the line indicates the timeframe that it came from. You can now delete some non relevant levels to reduce clutter on your trading screen.
Example of Support and resistance trading
When a support level breaks it becomes resistance and when a resistance breaks it becomes support.
In-fact a support level which has previously acted as resistance level is more important than others and similarly a resistance level which acted as support level previously is also more important.
In typical trading environment following occurs very frequently can be used as a simple support and resistance trading strategy.
- Price approaches a resistance and breaks through it. Price goes a small way up and then starts coming down again.
- The price coming down now halts at the old resistance level which has now become support level.
- The price reacts to this newly formed support and start moving up again.
- An aggressive trader can take entry at the new support level itself in the long direction. A more conservative approach will be to wait for the trend line break on a smaller timeframe and then take a long entry.
A price bounce from a previous resistance is one of the most significant entry points for traders.
Support and Resistance indicator
Following are some of the indicators that are used for identifying support and resistance levels.
- Moving averages
- Trend lines
- Fibonacci levels
- Pivot points
- RSI key levels
Lets take a look at all these in detail and see how we can use them in trading. These support and resistance levels work in forex , stocks and commodities as well.
Moving average as support and resistance
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.
Trendlines as support and resistance
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.
Fibonacci levels as support and resistance
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
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.
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.
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 40 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.
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.
Support and resistance analysis and how to use in trading
Well by now we have covered a lot on support and resistance. Support and resistance analysis is very important for a trader. Let it be for day trading or swing trading.
One can use any of the above tools and methods to analyze support and resistance areas and use then in trading.
In general using confluence of more than one method can really improve the accuracy of support / resistance level. Support and resistance lines should be used with Moving average / Fibonacci or any other method that we saw to identify the true dynamic SR levels.
A stock price can move in any direction , it can move fast or slow and it can reach any level higher and lower compared to its current value. If we consider all these variables it will practically be impossible to identify where and how to trade a stock.
We need to find out levels where we can trade the stock, either buy or sell. Identifying these levels is the fundamental use of support and resistance.