What is Support and Resistance?
Support and resistance is a technical analysis concept, where the price of an exchange rate or stock is likely to pause and then reverse at a pre-established price level.
These levels are identified with multiple touches of the price which holds and doesn’t break.
Support is an area/level of price where a financial asset meets demand and rebounds higher, stopping its downward trend. This potentially puts a “floor” below the price.
Example of support:
Resistance is an area/level of price where a financial asset meets supply and rebounds lower, stopping its upward trend. This potentially puts a “ceiling” below the price.
Example of resistance:
According to John J Murphy who is considered the father of inter-market technical analysis:
“support is a level or area on the chart under the market where buying interest is sufficiently strong to overcome selling pressure. As a result, a decline is halted and prices turn back again. . . . Resistance is the opposite of support”
Support and resistance (S&R) is one of the most important concepts for a trader to master, as these areas of supply and demand are almost universally used by traders in short term trading and speculation, and are a significant tool that helps to predict intraday price reversals.
It is one of the most basic building blocks of technical analysis.
Pro tip: support and resistance can be an area of price, not just a single price level.
How to identify support and resistance levels
Identifying support and resistance is not an exact science but it’s easy to do once you know how. The best way to identify support and resistance levels is to visually assess recent price action and then mark the important levels. It’s as simple as that:
- Select a time frame (Levels found on a higher time frames are stronger). The weekly and monthly time frames can provide significant levels, but for intraday trading the time frames between 15 mins and the daily will do.
- Mark levels where price had a difficult time breaking through or failed to breakthrough. This is usually where price swung to a low or a high and the reversed, or came close to touching a price multiple times.
- Keep it simple. Only mark the levels which look significant. Too many levels on your chart will make it confusing and difficult when you come to make a trade, as there will be too many levels to clearly see what is happening. Just mark the important looking levels.
So that’s the most common and effective way of identifying support and resistance.
Support becomes resistance and vise versa
Once broken by a significant amount, support becomes resistance and vise versa.
This is due to losing traders wanting to limit their losses and manage their risk, for example, a trader who gets long at a support level only to see that level broken will try to sell near or at their original entry point in order to limit their losses. Therefore buyers of this level now become sellers, and support turns into resistance.
This role reversal contributes to a trending market, with every reversed level acting as a rung or step on the ladder of the prevailing trend.
In a downtrend, previous support becomes resistance:
In a uptrend, previous resistance becomes support:
Pro Tip: If price brakes and closes above a resistance level, it means that resistance has been “broken”, and vice versa with support.
Static Support and resistance
There are two different types of S&R, static and dynamic. A static level is one that doesn’t change over time.
Types of static S&R:
- Fibonacci retracement
- Pivot points
- Previous highs and lows
Dynamic support and resistance
Dynamic support and resistance is a price level that evolves with the market in real time, as opposed to a static level which does not change with time.
Examples of dynamic support and resistance:
- Moving averages
- Ichimoku Kinko Hyo
- Gann fans
- Bollinger Bands
The simplest example of dynamic S&R is a moving average. The 200 daily moving average is seen as one of the most important moving averages and often sees a reaction when price meets it.
How to trade support and resistance
You can trade Support and Resistance by making trades at those levels of interest, going long if you think that level will provide support and going short if you think that level will provide resistance. It prudent risk management to have a tight stop when trading support and resistance.
Strategies for trading support and resistance:
- Breakout Strategy
When price breaks and closes behind a S&R level, take a position in the direction of the breakout.
- Role Reversal Strategy (seen in trending markets)
Previous support becomes resistance and vise versa, take a position on the retest of the broken level.
- Range Strategy (seen in ranging markets)
S&R levels continue to play their role, which keeps price in a range, get long at support and get short at resistance.