Support and Resistance

Support and Resistance
Support and resistance is one of the most widely used tools in trading. We monitor highs and lows because when a price gets near a previous high or low, the market will try to create a new high or low in the market.

Many traders do not understand the significance of the last relative highs and lows. Not all highs and lows are support and resistance.
High = A high candle with 2 lower candles to its left and 2 lower candles to its right.
Low = A low candle with 2 higher candles to its left and two higher candles to its right.
Market High (Resistance) Market Low (Support)

As we can see from the above diagram the length shape and colour of the candles make no difference provided there are 2 candles to the left and 2 candles to the right of the respective highs and lows.


Resistance = sequential highs on a chart reading from left to right. This is where there are likely to be more sell orders than buy orders. Resistance is a price where selling is strong enough to interrupt and reverse an up trend. When an uptrend hits a ceiling of resistance it is like a rubber ball that’s hits an object and bounces back off it.

Support = sequential Lows on a chart reading from Right to left. This is where there are likely to be more buy orders than sell orders. Support is a price where buying is strong enough to interrupt and reverse a down trend. When a down trend hits a floor of support it is like a rubber ball that’s hits an object and bounces back off it.

In trading there is a constant “Financial war going on between the Bulls (buyers) and the bears (sellers)” The bulls want the prices to go up and the bears want the prices to come down.

Bulls are always trying to achieve new highs and bears are trying to achieve new lows. When the bulls are in control they are always trying to take the prices to new highs. When the bears are in control they are always trying to take the prices to new lows.


The Support and resistance lines have been filled in on the above 4 hr GBP/USD Chart. I have colour coded the various support and resistance areas where the price reversed at a previous support or resistance line. Click to enlarge the chart and you will see that on almost every occasion price tested those lines on two or more occasions.

Many traders place their stop losses above or below the previous support and resistance levels. When chasing profits traders move stop losses to the next high or low in the market to lock in profits. This causes a build up of orders at these levels often causing price to stop and reverse direction.

The longer a support or resistance area holds, determined by the period of time or the number of bounces or hits the stronger or more impenetrable it tends to be. Remember too that support or resistance are not exact numbers but areas on a chart where price is likely to reverse.

By regularly placing our support and resistance lines on the charts we will soon learn to identify the minor and major support and resistance. By regularly placing our support and resistance lines we will always be aware of areas where there is likely to be a reversal.


Support becomes Resisstance and Resistance becomes Support.
Often when price breaks short through an area of support it retraces and retests that same area which then becomes resistance. The same is true that when price breaks long through a resistance area it retests that same area which has now become support. By clicking on the above chart we can identify a number of areas where previous support areas become resistance. In almost each case the resistance held and price continued to fall.

Trading Support and Resistance.
Many traders use support and resistance to identify new trading opportunities. When price breaks through a support or resistance area it often goes to the next support or resistance area.

These support and resistance areas offer not only an entry point but also a stop loss area and a target area. This makes it easy to calculate our risk to reward ratio.

How do we know if a Support or Resistance area has been broken?

As Price often breaks through a support or resistance line then retraces and continues in the opposite direction it is not always easy to identify early on whether price support or resistance has been broken. One way is to wait for a breakout candle which must open clear of our support or resistance area. Some traders still wait for a confirmation candle which must surpass the high or low of the breakout candle. Often the breakout is accompanied by increased volumes and waiting for a further confirmation candle could be too late and almost at the end of the run.

The above chart shows breakout candles and entry points. The same criteria can be used for a bounce off a support or resistance area.

Conclusion

• Plot your support and resistance area daily, they will help you determine the likely moves for the day.
• Support and resistance areas can help identify entry points for trades.
• They can also help with money management in determining Risk to reward ratios for trades.
• They can also help to identify stop loss and profit target areas for trades.