Support and Resistance
One of the most powerful price action concepts you will need to learn in order to master technical trading is that of support and resistance. We highly recommend that you develop the skill to identify these levels and draw them accurately on your charts.
Simply put, support is a price floor that prevents price from falling lower, while resistance is a price ceiling that prevents price from rising higher.
- Support and resistance levels are formed by historic price action and remain in effect until future price action negates them.
- Support and resistance levels form on all timeframes, but the higher the timeframe, the greater the probabilities they will hold.
- Understand that support and resistance levels can range in width from one pip on a one-minute chart to hundreds of pips on a monthly chart. In essence, they are zones, and you must be flexible in how you draw them and use them in your trading
Tip: When trading on the lower timeframes, be sure you are aware of key support and resistance levels that may have formed on the higher timeframes.
What causes support and resistance levels?
- A support level is established when price falls to the level and fails to close below. It is okay for the candle wick on the timeframe being traded to temporarily penetrate the support level as long as the candle does not close below the level.
- A resistance level is established when price rises to the level and fails to close above. It is okay for the candle wick on the timeframe being traded to temporarily penetrate the resistance level as long as the candle does not close above the level.
Ideally, price will attack the level at least twice and be rejected each time. The second and subsequent rejections confirm the validity of the level. In other words, this proves that the market’s inability to penetrate the level was not a random event.
To appreciate what we are saying, it is necessary to understand that the rejection of price at a support or resistance level is caused by market participants opening positions in the opposite direction. For the most part, the orders are limit orders placed in advance. The traders who placed these orders are betting that price is going to reverse.
Why do support and resistance levels eventually fail?
At any support or resistance level, a finite number of market participants are prepared to open trades in the opposite direction when prices reaches the level. Once all of these traders have opened their positions, price is free to pass through the level without opposition.
- A support level is negated when price closes below.
- A resistance level is negated when price closes above.
Tip: When trading support and resistance levels, you’ll find that, while some levels are obvious, many are not. Since all traders read the charts differently, the less obvious levels are more likely to exist as zones. If you consider a level to have the characteristics of a zone, look not just for one candle to close above or below but for two or three. This will increase the probabilities that the entire zone has been erased.
Support Equals Resistance/Resistance Equals Support
A key principal of price action trading is that when support is negated, it transforms into resistance. Conversely, when resistance is negated, it transforms into support.
The initial break of support indicates that the sellers have overwhelmed the buyers at that level. If prices retraces back up to the level, it will likely be met by more willing sellers, who will prevent price from rising further and possibly push it even lower.
The initial break of resistance indicates that the buyers have overwhelmed the sellers at that level. If prices retraces back down to the level, it will likely be met by more willing buyers, who will prevent price from falling further and possibly push it even higher.
3 Rules for determining accurate support and resistance levels
- Price should be rejected at least twice from the level.
- A level is stronger if it has served as both support and resistance.
- Recent rejections are more relevant that older rejections.
When you see price approaching an important support or resistance level, be extra alert. Price could stall, bounce or reverse direction entirely. For this reason, we strongly recommend that you invest the time to thoroughly understand support and resistance and incorporate this knowledge into your trading plan.
Good luck in your trading!
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