How to Trade with Support and Resistance

In this article, our focus will be on the art of trading with Support and Resistance within the realm of trading. To fully grasp this concept, I recommend revisiting our prior article where we delved into Head and Shoulder Patterns in Trading. Within this current article, we will explore various critical aspects related to effectively utilizing Support and Resistance in trading, including:

- Defining Support and Resistance.

- Strategies for Trading with Support and Resistance.

- Understanding the Psychological Aspects of Support and Resistance.

- Differentiating Between Support/Resistance Levels and Zones.

- Examining Various Types of Support and Resistance.

- Utilizing Multi-Time Frame Analysis for Support and Resistance.

- Identifying Where Support and Resistance Levels Are Typically Formed.

- Evaluating the Strength of Support and Resistance Zones.

- Recognizing the Signs of Support and Resistance Breakouts.

What are SUPPORT AND RESISTANCE?

SUPPORT

Support can be defined as the point in the market where there is enough demand from buyers to not only halt a downtrend in prices but potentially reverse it, initiating an upward movement. It signifies a level where buyers find the price attractive, making it a fair value proposition, especially considering the risk-to-reward ratio in favor of buyers.

RESISTANCE

Resistance, on the other hand, can be described as the point in the market where there is ample selling activity, both ongoing and potential, which is sufficient to temporarily halt an uptrend in prices and potentially even cause a reversal, pushing prices downward. It represents a level where sellers perceive the price as fair and often comes with a risk-to-reward ratio that favors sellers due to the potential for price decline.

FLIPPING

These price levels exhibit a dynamic characteristic where they frequently transition between acting as support and resistance. When a previous resistance level is successfully broken, it transforms into a support zone during future downtrends. Similarly, a former support level that gets breached becomes a resistance zone in subsequent upward movements. This highlights the adaptable nature of these price levels in the market's ever-changing dynamics.

Why are Support and Resistance important?

These points aren't arbitrary; they're a reflection of market dynamics. They represent moments when the forces of supply and demand shift temporarily. For instance, when the market fails to surpass a swing high, it signifies that, at that particular time, no one was willing to pay a price higher than that swing high. Traders perceived no added value above that level.

Therefore, when the price approaches, nears, or exceeds a swing high in the future, it's essential to recall that traders previously found no value in buying beyond that point. Assuming most traders' sentiments haven't changed significantly, it's improbable that prices will exceed the swing high. Consequently, the swing high marks a price area that acts as a barrier, preventing the market from moving upward, which we refer to as a resistance area. This concept reverses for support areas.

Once you've grasped the market's structural dynamics, the next step is to determine the current phase the market is experiencing. This entails identifying whether it's in an accumulation phase, distribution phase, upward trend, or downward trend. Understanding the phase is crucial for making informed trading decisions based on the prevailing market conditions.

The Psychology of Support and Resistance

Let's categorize market participants into three groups: longs, shorts, and the uncommitted. Here's how they behave when the price approaches a support level:

1. Longs: These traders have already bought contracts and are currently in the market. When the price nears a support level, they may become eager to add more positions, hoping to capitalize on the opportunity for lower prices.

2. Shorts: Traders in this category have taken positions on the selling side and are looking for price declines. As the price approaches the support area where they initiated their short positions, they wish for a retracement that would break even or allow them to exit with minimal losses.

3. Uncommitted Traders: This group includes individuals who have either stayed out of the market or are undecided about their trading direction. When they witness the market starting to rise from a support area where prices have been consolidating, they recognize a favorable entry point for long positions.

In essence, traders who fear missing out on potential gains tend to enter the market when prices approach a support level, especially if buying pressure is strong enough. This influx of buying interest can lead to a market reversal at that support location.

Consider a scenario where a market begins to ascend from a support zone where prices have been consolidating or moving within a range for a considerable period.

1. Long Traders: Those who are already long in the market are pleased with the price increase, but they might have a tinge of regret for not buying more at lower levels. They anticipate that if the market retraces and approaches the support area again, they could seize the opportunity to increase their long positions.

2. Short Traders: On the flip side, traders who have taken short positions now find themselves on the wrong side of the market trend as prices climb. These short traders are essentially hoping (and sometimes praying) for a price dip back to the area where they initiated their short positions. This dip would enable them to exit the market around their entry point, minimizing potential losses (referred to as their break-even point).

The last group, the uncommitted traders, recognize that the market is trending upwards. They decide to participate in the market by taking long positions during the next favorable buying opportunity.

What's important to understand is that all four groups of traders have a shared interest in the support area beneath the market. They are all determined to "buy the next dip" if prices happen to decline near that support level. When this occurs, renewed buying from these groups collectively exerts upward pressure on prices.

Now, let's consider the opposite scenario where prices begin to decline instead of moving higher. In the previous situation, as prices were rising, the collective response of market participants led to additional buying each time prices pulled back, effectively creating new support levels. However, if prices start to fall and drop below the previous support zone, the dynamics change.

In this case, all those who had previously bought in the support zone realize that their decision was incorrect. The support that was previously formed by the participation of the longs, shorts, and uncommitted traders now functions differently. Instead of supporting prices, it acts as a barrier to further price increases. This happens because the buy orders that were initially placed below the market have now turned into sell orders above the market. Consequently, the support zone has transformed into a resistance zone, restricting the upward movement of prices.

Support and Resistance Level and Zone

Support and resistance levels are more specific, represented by single lines, while support and resistance zones are broader areas. In practice, both support and resistance levels and supply and demand zones are derived from the same foundational concept.

Support and resistance areas, often referred to as zones, are preferred over single lines for two main reasons:

1. Price "Undershoot": Sometimes, prices may briefly dip below a specific level, causing traders to miss a potential trade if they only focus on that precise line as a reference point.

2. Price "Overshoot": Conversely, prices may temporarily exceed a particular level, leading traders to assume that support or resistance has been breached when, in fact, it's still relevant.

Using support and resistance zones provides a more flexible and encompassing approach to understanding where buying and selling interest is concentrated in the market.

Let me clarify this with an example...

Price "undershoot" occurs when the market approaches the support or resistance line but doesn't quite reach it. Instead, it reverses direction before hitting your exact support or resistance level. In this situation, you might miss a potential trade because you were waiting for the market to precisely test that specific SR level.

This price reversal phenomenon is often referred to as "123 reversals" or when the market holds a slightly higher support level or lower resistance level. It typically happens due to the actions of aggressive buyers and sellers in the market.

An example: OF PRICE UNDERSHOOT

"Price 'overshoots'" is a scenario where the market goes beyond established support or resistance levels, leading traders to believe that these levels have been convincingly broken. As a result, they enter trades based on the breakout, anticipating a new trend. However, it often turns out to be a false breakout, causing traders to incur losses.

This type of price action is commonly referred to as "Upthrust" and "Spring."

- Upthrust: Upthrust occurs when the market rises above a resistance level, causing traders to think a breakout is happening. However, it reverses quickly and moves back below the resistance, trapping traders who entered long positions. This is a bearish signal.

- Spring: Conversely, a Spring occurs when the market drops below a support level, suggesting a breakdown. Yet, it swiftly reverses and climbs back above the support, trapping traders in short positions. This is a bullish signal.

Both Upthrust and Spring are classic examples of market manipulation, where institutions and big players intentionally push prices beyond key levels to trigger stop-loss orders and then reverse the market for their benefit. Traders should be cautious when dealing with apparent breakouts and consider the possibility of Upthrusts and Springs to avoid falling into these traps.

Let’s DO AN EXAMPLE OF PRICE OVERSHOOT

So, how do you solve these two problems?

Indeed, it's quite simple: Support and Resistance are better viewed as areas on the chart rather than precise lines.

Here's why:

1. Price "Undershoot": By recognizing Support and Resistance as areas, you acknowledge that price may come close to these levels without hitting them precisely. This flexibility allows you to consider a trade even if the market doesn't touch your expected level. It helps you avoid missing potential opportunities when price reverses from near the area, a phenomenon sometimes referred to as a "123 reversal." This can occur because of the actions of aggressive buyers and sellers who influence price movement in the vicinity of support or resistance.

2. Price "Overshoot": When you view Support and Resistance as areas, you're less likely to fall into the trap of assuming a breakout when price appears to surpass these levels. False breakouts, known as "Upthrusts" and "Springs," can be misleading. Recognizing Support and Resistance as zones allows you to remain cautious, consider the possibility of these market manipulations, and not rush into trades based solely on apparent breakouts.

So, embracing Support and Resistance as areas rather than rigid lines helps you navigate the nuances of price action and make more informed trading decisions.

How to draw support and resistance zone

Here's a two-step process to identify Support and Resistance (SR) Zones effectively:

Step 1: Begin by switching to a line chart, which simplifies the view of price action. Here, you'll want to identify points on the chart where price experiences significant rejections or changes in direction. These are the key areas where Support and Resistance are likely to form.

Step 2: Once you've marked these critical points on the line chart, switch back to the candlestick chart, which provides more detailed information about price movements. Now, focus on the candles that correspond to the marked rejections on the line chart. Identify the highest point (for resistance) or the lowest point (for support) of the candle nearest to the marked line. These high and low points, in conjunction with the marked rejections, define your Support and Resistance Zones.

By following this two-step process, you create well-defined SR Zones that take into account both the historical rejections seen on the line chart and the specific price levels indicated by the candlestick chart, giving you a comprehensive view of potential areas of interest on your trading chart.

Let’s do an example of drawing an SR zone

TYPES OF SUPPORT AND RESISTANCE

There are different types of Support and Resistance in trading. Here are the three main types:

1. Horizontal Support and Resistance: These are price levels where the market has shown a tendency to reverse or stall in the past. They form horizontal lines on your chart. When prices reach these levels, traders often expect a reaction, which can lead to reversals, bounces, or consolidations. These levels are based on historical price action and can be key reference points for traders.

2. Dynamic Support and Resistance: Dynamic levels are not fixed like horizontal ones but change as the market moves. A common type of dynamic support and resistance is the moving average. Traders use moving averages to identify trends and potential reversal points. When prices approach a moving average, it can act as dynamic support or resistance, depending on whether the market is trending up or down. Moving averages smooth out price data, providing a clearer trend direction.

3. Trend Line Support and Resistance: Trend lines are drawn on charts to represent the prevailing trend's slope and act as areas of potential support (in an uptrend) or resistance (in a downtrend). Connecting significant swing lows in an uptrend or swing highs in a downtrend with a line helps traders visualize the trend's strength and possible reversal points. When prices approach a trend line, traders look for reactions that may indicate trend continuation or reversal.

Each type of support and resistance has its advantages and can be used in different trading strategies. Traders often combine multiple types to gain a more comprehensive understanding of potential price levels that can influence their trading decisions.

LET’S FIND ALL THE ABOVE SUPPORT AND RESISTANCE IN A SINGLE CHART

Multi timeframe SUPPORT AND RESISTANCE;

Certainly, multi-timeframe analysis of Support and Resistance (SR) is a valuable tool in trading. Here's what you need to know:

1. Timeframe Matters: The effectiveness of support and resistance levels depends on the timeframe you're examining. In general, higher timeframes, like daily or weekly charts, tend to have stronger and more reliable SR levels. This is because they represent a broader view of the market and are watched by many traders and institutions. Therefore, they can be significant reference points for price.

2. Higher Timeframes, Greater Reliability: When you use SR levels from higher timeframes, they often carry more weight and provide more reliable signals. These levels are significant to a broader range of market participants and are more likely to influence price behavior.

3. Noise in Lower Timeframes: Lower timeframe charts, like 5-minute or 15-minute charts, are more susceptible to market noise and quick fluctuations. SR levels on these charts may not hold as strongly or be as dependable for trading decisions. Traders on these lower timeframes should exercise caution and consider the broader context from higher timeframes.

4. Top-Down Analysis: To make the most informed trading decisions, many traders use a top-down approach. They start by analyzing higher timeframes to identify major SR levels and the overall trend. Then, as they move to lower timeframes for entry and exit decisions, they give more weight to the SR levels identified on the higher timeframes.

In summary, understanding and utilizing support and resistance levels across different timeframes is a powerful way to improve trading decisions. Higher timeframes offer more reliable levels, while lower timeframes may have more noise and less dependable SR. Combining both perspectives through top-down analysis can lead to more effective trading strategies.

Honing in on significant support and resistance (SR) levels is crucial for effective trading. Here's how to do it:

1. Start with Higher Timeframes: Begin your SR analysis by looking at higher timeframes, such as weekly or daily charts. These levels often carry more weight because they are observed by a broader range of market participants.

2. Identify Key SR Levels: On these higher timeframes, pinpoint the major SR levels. These are the ones that have historically played a significant role in influencing price movements. You can typically identify them by looking for areas where price has reversed, paused, or shown significant trading activity.

3. Apply to Your Trading Timeframe: Once you've determined the key SR levels on the higher timeframe, bring this knowledge down to your trading timeframe. For instance, if you're trading on a daily chart, transfer the significant SR levels you identified on the weekly chart to your daily chart.

4. Focus on the Essentials: By doing this, you can concentrate on the most important SR levels that are more likely to impact price action on your trading timeframe. This approach prevents your chart from becoming cluttered with numerous, less influential SR levels.

In essence, this method streamlines your analysis, helping you zero in on the most crucial SR levels for your trading decisions. It's a strategic way to maintain focus and avoid being overwhelmed by an excess of potential SR zones on your chart.

WHERE SUPPORT AND RESISTANCE DEVELOPED?

Support and resistance (SR) levels can emerge from various sources and price behaviors. Here's where they typically develop:

1. Prior Bar's High and Low: The first and most immediate SR levels in any timeframe are often derived from the previous bar's high (for resistance) and low (for support).

2. Pivot Points: Pivot points, including swing highs and swing lows, are key SR levels. These are areas where the market has made a noticeable change in direction.

3. Consolidation Areas: When the price consolidates, moving in a relatively tight range, this range's upper and lower boundaries can act as SR levels. Breakouts from these zones are often significant.

4. Rejection from an Area: When price repeatedly attempts to move past a certain level but is rejected, this creates a potent SR zone. It signifies strong buying or selling pressure at that point.

5. Previous SR Levels: Levels that have previously acted as both support and resistance in the past tend to retain their significance in the future. Traders remember these zones.

6. Gaps: Price gaps, especially if they leave an "invisible tail," represent an emotional point in the market. These areas can act as SR levels.

7. Fibonacci Retracement: Fibonacci levels, such as the 38.2%, 50%, and 61.8% retracement levels, are frequently used as SR levels.

8. Trend Lines and Moving Averages (MA): Trend lines, drawn along the trend direction, and moving averages can also provide support or resistance. When price touches or crosses them, they often influence trader decisions.

Remember, these SR levels can be used individually or in combination, depending on your trading strategy and the specific dynamics of the market you're analyzing. Understanding where SR levels originate is a fundamental aspect of technical analysis.

Rejection from an area

LAST SWING HIGH AND LAST SWING LOW

Swing highs and swing lows are crucial turning points in the market. They represent moments where the price has made significant reversals or shifts in direction. As such, they are natural choices for identifying and projecting support and resistance zones on a price chart.

A **swing high** occurs when the price reaches a peak before reversing and moving lower. It's essentially a local high point in the price movement. Conversely, a **swing low** is a valley in the price chart where it hits a low before reversing and moving higher. These points mark areas where the market has experienced changes in sentiment, with buying pressure overwhelming selling pressure at swing lows and vice versa at swing highs.

Traders often pay close attention to these swing points because they can provide valuable insights into future price movements. Identifying and drawing support and resistance zones based on swing highs and lows can help traders make informed decisions about entry and exit points, stop-loss placements, and overall trade strategies.

In summary, swing highs and swing lows serve as critical reference points for projecting support and resistance zones, offering traders a clearer understanding of market dynamics and potential price reversal areas.

CONGESTION AREAS

Genius Investor has invested a significant amount of time and trading activity within a specific price range known as a congestion area. This extended period in the congestion zone indicates that they have established real trading positions and interests at those price levels. Consequently, these areas of previous market congestion hold a high degree of significance and become reliable support and resistance zones.

In essence, when the market has spent an extended duration moving sideways within a particular price range, it suggests that traders and investors, including the Genius Investor, have found value and opportunity at those price levels. These zones represent price areas where buying and selling activity has been concentrated, resulting in a historical tug-of-war between bulls and bears.

As a result, these earlier congestion areas become reference points for future price action. Traders often anticipate that if the price returns to these zones, it's likely to encounter support if it moves into a former congestion area from below or resistance if it approaches from above. These zones serve as strategic locations for traders to consider entry or exit points and can play a pivotal role in shaping trading decisions.

In summary, when Genius Investor and others have actively participated in a congestion area for an extended period, these regions gain significance as reliable support and resistance zones, providing valuable insights for traders in their decision-making processes.

MA AND FIBO RETRACEMENT

You can also identify support and resistance levels by using moving averages, and these tend to be most effective when the market is trending.

Fibonacci retracement is a widely used technique to determine support and resistance levels. It involves identifying significant market swings and then assessing the retracement of that move based on Fibonacci ratios such as 23.6%, 38.2%, 50%, 61.8%, and 100%. These levels can provide valuable insights into potential price reversals or continuations.

FLIPPING OF SUPPORT/RESISTANCE

Price levels that flip roles, serving as both support and resistance, are crucial in technical analysis. When a resistance level is breached and the price moves above it, it indicates a shift in power from sellers to buyers. At this point, the previous resistance level often becomes a new support level, marking a significant change in market dynamics. This concept helps traders identify potential reversal points and plan their trades accordingly.

How strong support and resistance

The strength of a support or resistance level can be evaluated based on several key factors:

1. Number of Occurrences: The first time the price retraces to a particular area, it often exhibits strong support or resistance. Subsequent retests of the same level may weaken its significance.

2. Volume: Higher trading volume at a specific price level increases the likelihood of that level becoming significant support or resistance. It suggests strong buying or selling interest.

3. Price Departure: The manner in which price moves away from a support or resistance zone can indicate its strength. A strong departure signifies an imbalance in supply and demand at that zone, often driven by significant trading activity, possibly initiated by experienced investors.

4. Time Spent at the Zone: The less time the price lingers at a support or resistance zone, the stronger it tends to be. It implies that the market swiftly recognized the value at that level, leading to a quick price response.

5. Distance Moved Away: When the price moves far away from a support or resistance zone before eventually returning to it, the level is considered stronger. This indicates a substantial imbalance in supply and demand, potentially offering a higher reward-to-risk ratio for trades.

By assessing these factors, traders can gauge the strength of support and resistance levels and make more informed decisions in their trading strategies.

When support and resistance break

As long as prices remain above or at the same level as a prior significant low, even if they start to weaken in the upper regions of the chart, it indicates that the bullish sentiment is still technically prevailing. However, when bulls have exerted significant control in the past, it becomes less probable for the market to reverse its course at the first sign of a downturn. In essence, strong previous dominance by the bulls can act as a buffer against immediate reversals.

- Support levels often give way in the presence of a downtrend, signaling a shift in market sentiment towards selling.

- Conversely, resistance levels tend to break when an uptrend is in play, indicating a change in market sentiment towards buying.

- Support and resistance levels are more likely to break when there is a narrow trading range at these levels, suggesting that a breakout might be imminent.

- The more frequent a support or resistance level is tested, the weaker it tends to become, increasing the likelihood of it eventually breaking.

The more times Support or Resistance (SR) is tested, the weaker it becomes and breaks the level

Here’s why…

The market often experiences reversals at resistance levels due to the presence of selling pressure that pushes prices lower. This selling pressure can originate from various sources, including large institutions, banks, or astute investors executing substantial orders.

Consider this scenario: When the market repeatedly tests a resistance level, it's essentially working to fill all those sell orders that exist at that level. Once all these sell orders have been executed, there are fewer sellers remaining in the market.

This situation highlights the determination of market participants to break through resistance or support levels. The more frequent testing of resistance suggests aggressive efforts by buyers, especially when there are higher lows approaching the resistance level. This higher low formation signifies the buyers' determination to overcome resistance and push prices higher.

LET’S DO AN EXAMPLE

When you observe higher lows forming near a resistance level, it often leads to a breakout, which is similar to the formation of an ascending triangle pattern. Conversely, lower highs emerging near a support level typically result in a breakdown, akin to the formation of a descending triangle pattern.

In essence, these patterns reflect the battle between buyers and sellers. Higher lows near resistance indicate increasing buying pressure that may eventually break through resistance. Conversely, lower highs near support suggest growing selling pressure that can lead to a breach of support. These patterns are important signals for traders and analysts in anticipating potential price movements.

Resistance tends to break into an uptrend

In an uptrend, the key to its continuation lies in the market's ability to consistently achieve new highs. Therefore, attempting to short the market at resistance levels during an uptrend is generally considered a low-probability trade. Instead, a more favorable approach is to consider long positions when the market approaches support levels or when there's a breakout above the previous high. This strategy aligns with the idea that in a healthy uptrend, buying near support or trading breakouts can offer better trade opportunities compared to trying to sell at resistance.

Support tends to break into a downtrend

In a downtrend, the trend's continuation relies on the market consistently achieving new lows. Consequently, attempting to go long (buy) at support levels during a downtrend is generally not advisable. Instead, a more favorable strategy is to consider short positions (selling) when the market approaches resistance levels or when there's a breakout below the previous swing low. This approach aligns with the concept that in a sustained downtrend, selling at resistance or trading breakouts below prior lows can provide more favorable trading opportunities.

Support and Resistance tend to break when there’s a tight range

Resistance typically represents an area where selling pressure is expected to emerge, implying that prices should decline from there. However, when the price doesn't immediately decrease but rather consolidates or moves sideways at the resistance level, it suggests something significant. This consolidation is often seen as a sign of strength because it indicates that the bears, or sellers, are struggling to push the price lower. There might be a lack of selling pressure or even a notable presence of buying pressure. In either case, this scenario is unfavorable for the bears, and it increases the likelihood that the resistance level will eventually break. This phenomenon illustrates that the market's dynamics can change, potentially leading to a shift in the prevailing trend.

And the opposite for Resistance:

In the upcoming article, I will delve into Advanced Candlestick Analysis in Trading. In this present article, I've provided an extensive explanation of how to effectively trade with Support and Resistance. I trust you found this article on trading with Support and Resistance valuable and informative.

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