Support and Resistance is one of the most widely used concepts in trading. Strangely enough, everyone seems to have their own idea on how you should measure support and resistance.
As you look at the diagram above. This zigzag pattern is making its way up (bull market). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.
As the market stays up, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time. The reverse is true for the downtrend.
Support and Resistance represent the important moment where the forces of supply and demand meet. In the financial markets, prices are driven by excessive supply (down) and demand (up). Supply is synonymous with bearish, bears and selling. Demand is synonymous with bullish, bulls and buying.These terms are going to be used and at the end you will be familiarize with them.
Support
Support is the price level at which demand is thought to be strong enough to prevent the price from declining further. The logic dictates that as the price declines towards support and gets cheaper, buyers become more inclined to buy and sellers become less inclined to sell. By the time the price reaches the support level, it is believed that demand will overcome supply and prevent the price from falling below support.
Support does not always hold and a break below support signals that the bears have won out over the bulls. A decline below support indicates a new willingness to sell and/or a lack of incentive to buy. Support breaks and new lows signal that sellers have reduced their expectations and are willing sell at even lower prices. In addition, buyers could not be coerced into buying until prices declined below support or below the previous low. Once support is broken, another support level will have to be established at a lower level.
Resistance
Resistance is the price level at which selling is thought to be strong enough to prevent the price from rising further. The logic dictates that as the price advances towards resistance,sellers become more inclined to sell and buyers become less inclined to buy. By the time the price reaches the resistance level, it is believed that supply will overcome demand and prevent the price from rising above resistance.
Resistance does not always hold and a break above resistance signals that the bulls have won out over the bears. A break above resistance shows a new willingness to buy and/or a lack of incentive to sell. Resistance breaks and new highs indicate buyers have increased their expectations and are willing to buy at even higher prices. In addition, sellers could not be coerced into selling until prices rose above resistance or above the previous high. Once resistance is broken, another resistance level will have to be established at a higher level.
Something very important 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.
“Support and Resistance was broken”
Support or resistance level is broken if the market can actually close past that level. However, you will find that this is not always the case.
In this case, price had closed below the 1.4700 support level but ended up rising back up above it. If you had believed that this was a real breakout and sold this pair, you would’ve been seriously hurtin’! Looking at the chart now, you 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.
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 show you the closing price while candlesticks add the extreme highs and lows to the picture. When plotting support and resistance, you don’t want the reflexes of the market. You only want to plot its intentional movements.
Important things about Support and Resistance:
- They can be broken and retrace back to support/resistance levels.
- They break, and support becomes resistance, or resistance becomes support.
With a little practice, you’ll be able to spot potential support and resistance areas easily. In the next lesson, we’ll teach you how to trade diagonal support and resistance lines, otherwise known as trend lines.