What is Support and Resistance?

“Support and resistance” is one of the most widely used concepts in trading.

Strangely enough, everyone seems to have their own idea of how to measure support and resistance.

Let’s take a look at the basics first.

Look at the diagram above. This zigzag pattern is making its way up (a “bull market”).When the price moves up and then pulls back, the highest point reached before it pulled back is now resistance.

Resistance levels indicate where there will be a surplus of sellers.

When the price continues up again, the lowest point reached before it started back is now support.

Support levels indicate where there will be a surplus of buyers.

In this way, resistance and support are continually formed as the price moves up and down over time.

The reverse is true during a downtrend.

In the most basic way, this is how support and resistance are normally traded:

Trade the “Bounce”

• Buy when the price falls towards support.
• Sell when the price rises towards resistance.

Trade the “Break”

• Buy when the price breaks up through resistance.
• Sell when the price breaks down through support.

Plotting Support and Resistance Levels

One thing to remember is that support and resistance levels are not exact numbers.Often times you will see a support or resistance level that appears broken, but soon after find out that the market was just testing it.

With candlestick charts, these “tests” of support and resistance are usually represented by the candlestick shadows.

At those times it seemed like the price was “breaking” support, In hindsight, it is obvious that the price was merely testing that level.

So how to define if support and resistance were broken?

There is no definite answer to this question.

Some argue that a support or resistance level is broken if the price can actually close past that level.

However,  this is not always the case.

Let’s take a example and see what happened when the price actually closed past the 1.4700 support level.

In this case, the price had closed below the 1.4700 support level but ended up rising back up above it. If trader had believed that this was a real breakout and sold this pair, this would’ve been seriously hurting.

Looking at the chart now, trader can visually see and come to the conclusion that the support was not actually broken; it is still very much intact and now even stronger.

Support was “breached” but only temporarily.

One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart.

The reason is that line charts only shows the closing price while candlesticks add extreme highs and lows to the picture.

Other interesting tidbits about support and resistance:

• When the price passes through resistance, that resistance could potentially become support.
• The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
• When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.

Trend Lines

Trend lines are probably the most common form of technical analysis in forex trading.

They are probably one of the most underutilized ones as well.

If drawn correctly, they can be as accurate as any other method.Unfortunately, most forex traders don’t draw them correctly or try to make the line fit the market instead of the other way around.

In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys).

This is known as an ascending trend line.

In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

This is known as a descending trend line.

Types of Trends

There are three types of trends:

1. Uptrend (higher lows)
2. Downtrend (lower highs)
3. Sideways trend (ranging)

Here are some important things to remember using trend lines in forex trading:

It takes at least two tops or bottoms to draw a valid trend line but it takes THREE to confirm a trend line.

The STEEPER the trend line is, the less reliable it is going to be and the more likely it will break.

Like horizontal support and resistance levels, trend lines become stronger the more times they are tested.

Trend Channels

If take this trend line theory in one step further and draw a parallel line at the same angle of the uptrend or downtrend, then “channel” will be created.

The upper trend line marks resistance and the lower trend line marks support. So both the tops and bottoms of channels represent potential areas of support or resistance.

Trend channels with a negative slope (down) are considered bearish and those with a positive slope (up) are considered bullish.

To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to a position where it touches the most recent peak. This should be done at the same time you create the trend line.To create a down (descending) channel, simply draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley. This should be done at the same time you create the trend line.

When prices hit the LOWER trend line, this may be used as a buying area.

When prices hit the UPPER trend line, this may be used as a selling area.

Types of Trend Channels

There are three types of channels:

1. Ascending channel (higher highs and higher lows)
2. Descending channel (lower highs and lower lows)
3. Horizontal channel (ranging)

Some traders prefer to use the terms “rising channel” for an ascending channel and “falling channel” for a descending channel.

Important things to remember about drawing trend channels:

When constructing a trend channel, both trend lines must be parallel to each other.

Generally, the bottom of the trend channel is considered a “buy zone” while the top of the trend channel is considered a “sell zone”.

A channel boundary that is sloping at one angle while the corresponding channel boundary is sloping at a different angle is not correct and could lead to bad trades.

When this happens, this chart pattern is no longer a trend channel but a triangle. (which you will learn about more later).

That said, trend channels don’t have to be completely parallel. Nor does 100% of price action have to fit within the channel.

A common mistake many traders make is that they only look for textbook price patterns.

They miss important information about price action and close their eyes to other important clues.

How to Trade Support and Resistance

Now that the basics of how to trade support and resistance has been explained , it’s time to apply these basic but extremely useful technical tools in your trading. It divided how to trade support and resistance levels into two simple ideas: the Bounce and the Break.

The Bounce

As the name suggests, one method of trading support and resistance levels is right after the bounce.

Many retail forex traders make the error of setting their orders directly on support and resistance levels and then just waiting for their trade to materialize.

Sure, this may work at times but this kind of trading method assumes that a support or resistance level will hold without price actually getting there yet.

When playing the bounce, trader want to tilt the odds in their favor and find some sort of confirmation that the support or resistance will hold.

For example, instead of simply buying right off the bat, traders want to wait for it to bounce off support before entering.

Same, traders want to wait for it to bounce off resistance before entering.

By doing this, those moments where price moves fast and breaks through support and resistance levels can be avoided. From experience, catching a falling knife when trading can get really bloody!

The Break

There are two ways to play breaks in trading: the aggressive way or the conservative way.

The simplest way to play breakouts is to buy or sell whenever price passes convincingly through a support or resistance zone.

The keyword here is convincing because traders only want to enter when the price passes through a significant support or resistance level with ease.

Traders want the support or resistance area to act as if it just received a Chuck Norris karate chop: We want it to wilt over in pain as price breaks right through it.

The Conservative Way

Instead of entering right on the break, wait for the price to make a “pullback” to the broken support or resistance level, and enter after the price bounces.

Summary: Trading Support and Resistance

When the price moves up and then pulls back, the highest point reached before it pulls back is now resistance.

As the price continues up again, the lowest point reached before it climbs back up is now support.

Support and Resistance are Zones

One thing to remember is that support and resistance levels are usually not exact numbers.

One way to find these zones is to plot support and resistance on a line chart rather than a candlestick chart.

Support and Resistance Can Reverse Roles

Another thing to remember is that when price passes through a resistance level, that resistance could potentially become support. The same could also happen with a support level. If a support level is broken, it could potentially become a resistance level

This concept is known as “role reversal“.

Trend Lines

In their most basic form, an uptrend line is drawn along the bottom of easily identifiable support areas (valleys).

In a downtrend, the trend line is drawn along the top of easily identifiable resistance areas (peaks).

There are three types of trends:

1. Uptrend (higher lows)
2. Downtrend (lower highs)
3. Sideways or trendless (ranging or flat)

Trend Channels

There are three types of trend channels:

1. Ascending channel (higher highs and higher lows)
2. Descending channel (lower highers and lower lows)
3. Horizontal channel (ranging)

To create an up (ascending) channel, simply draw a parallel line at the same angle as an uptrend line and then move that line to a position where it touches the most recent peak.

To create a down (descending) channel, simply draw a parallel line at the same angle as the downtrend line and then move that line to a position where it touches the most recent valley.

To create a sideways (horizontal) channel, simply draw a parallel line at a zero or flat angle.

How to Trade Support and Resistance

Trading support and resistance levels can be divided into two methods

1. The “bounce“
2. The “break“

When trading the bounce trader want to tilt the odds in our favor and find some sort of confirmation that the support or resistance will hold.

Instead of simply buying or selling right off the bat, wait for it to bounce first before entering.

By doing this, trader avoid those moments where price moves so fast that it slices through support and resistance levels like a knife slicing through warm butter.

As for trading the break, there is an aggressive way and there is a conservative way.

In the aggressive way, trader simply buy or sell whenever the price passes through a support or resistance zone with ease.

In the conservative way, trader wait for the price to make a “pullback” to the broken support or resistance level and enter after the price bounces.

Reference: https://www.babypips.com/learn/forex/types-of-charts