Trading Opportunities at Recently Created Levels of Support and Resistance

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How To Trade Based on Support and Resistance Levels

How to Use Support and Resistance to Make Better Trading Decisions

Simply put, an area of support is where the price of an asset tends to stop falling, and an area of resistance is where the price tends to stop rising. But traders really need more information about support and resistance beyond those simple definitions before they attempt to make trading decisions based on those areas in a chart.

To use support and resistance effectively, you first need to understand how asset prices typically move, so you can then interpret support and resistance from that framework. You also need to be aware that there are different types of support and resistance, such as minor and major/strong. Minor levels are expected to be broken, while strong levels are more likely to hold and cause the price to move in the other direction.

Using Trendlines

Support and resistance are highlighted with horizontal or angled lines, called trendlines. If the price stalls and reverses in the same price area on two different occasions in succession, then a horizontal line is drawn to show that the market is struggling to move past that area.

In an uptrend, the price makes higher highs and higher lows. In a downtrend, the price makes lower lows and lower highs. Connect the highs and lows during a trend. Then extend that line out to the right to see where the price may potentially find support or resistance in the future.

These simple lines highlight trends, ranges, and other chart patterns. They provide traders with a visual of how the market is currently moving and what it could do in the future.

Major and Minor Support and Resistance Levels

Minor support and resistance levels don’t hold up. For example, if the price is trending lower, it will make a low, then bounce, and then start to drop again. That low can be marked as a minor support area since the price did stall out and bounce off that level. But since the trend is down, the price is likely to eventually fall through that minor support level without much problem.

Areas of minor support or resistance provide analytical insight and potential trading opportunities. In the example above, if the price does drop below the minor support level, then we know the downtrend is still intact. But if the price stalls and bounces at or near the former low, then a range could be developing. If the price stalls and bounces above the prior low, then we have a higher low and that is an indication of a possible trend change.

Major support and resistance areas are price levels that have recently caused a trend reversal. If the price was trending higher and then reversed into a downtrend, the price where the reversal took place is a strong resistance level. Where a downtrend ends and an uptrend begins is a strong support level.

When the price comes back to a major support or resistance area, it will often struggle to break through it and move back in the other direction. For example, if the price falls to a strong support level, it will often bounce upward off it. The price may eventually break through it, but typically the price retreats from the level a number of times before doing so.

Trading Based on Support and Resistance

The basic trading method for using support and resistance is to buy near support in uptrends or the parts of ranges or chart patterns where prices are moving up and to sell/sell short near resistance in downtrends or the parts of ranges and chart patterns where prices are moving down.

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It helps to isolate a longer-term trend, even when trading a range or chart pattern. The trend provides guidance on the direction to trade in. For example, if the trend is down but then a range develops, preference should be given to short-selling at range resistance instead of buying at range support. The downtrend lets us know that going short has a better probability of producing a profit than buying. If the trend is up and then a triangle pattern develops, favor buying near support of the triangle pattern.

Buying near support or selling near resistance can pay off, but there is no assurance that the support or resistance will hold. Therefore, consider waiting for some confirmation that the market is still respecting that area.

If buying near support, wait for a consolidation in the support area and then buy when the price breaks above the high of that small consolidation area. When the price makes a move like that, it lets us know the price is still respecting the support area and also that the price is starting to move higher off of support. The same concept applies to selling at resistance. Wait for a consolidation near the resistance area, then enter a short trade when the price drops below the low of the small consolidation.

When buying, place a stop loss several cents (or ticks or pips) below support, and when shorting, place a stop loss several cents, ticks, or pips above resistance.

If you’re waiting for a consolidation, place a stop loss a couple cents, ticks, or pips below the consolidation when buying. When selling, the stop loss goes a couple cents, ticks, or pips above the consolidation.

When entering a trade, have a target price in mind for a profitable exit. If buying near support, consider exiting just before the price reaches a strong resistance level. If shorting at resistance, exit just before the price reaches strong support. You can also exit at minor support and resistance levels. For example, if you’re buying at support in a rising trend channel, consider selling at the top of the channel.

In some cases, you may be able to extract more profit if you let a breakout occur, instead of selling at minor support/resistance. For example, if you’re buying near triangle support within a larger uptrend, you may wish to hold the trade until it breaks through triangle resistance and continues with the uptrend.

There is also a concept that old support can become new resistance or vice versa. This isn’t always the case but does tend to work well in very specific conditions, such as a second chance breakout.

False Breakouts

Asset prices will often move slightly further than we expect them to. This doesn’t happen all the time, but when it does it is called a false breakout. If our analysis shows that there is support at $10, it is quite possible that the price could drop through $10, to $9.97 or $9.95 for example, and then start to rally again. Support and resistance are areas, not an exact price. Expect some variability in how the price acts around support and resistance. It is unlikely to stop at the exact same price as before.

False breakouts are excellent trading opportunities. One strategy is to actually wait for a false breakout, and enter the market only after it occurs. For example, if the trend is up, and the price is pulling back to support, let the price break below support and then buy when the price starts to rally back above support.

Similarly, if the trend is down, and the price is pulling back to resistance, let the price break above resistance and then short-sell when the price starts to drop below resistance.

The downside to this approach is that a false breakout won’t always occur. Waiting for one means good trading opportunities could be missed. Therefore, it is typically best to take trading opportunities as they come. If you happen to catch the odd false breakout trade, that’s a bonus.

Because false breakouts occur on occasion, the stop loss should be placed a bit of distance away from support or resistance, so that the false breakout isn’t likely to hit your stop loss position before moving in your anticipated direction.

Adapting Trading Decisions to New Support and Resistance Levels

Support and resistance are dynamic, and so your trading decisions based on them must also be dynamic. In an uptrend, the last low and last high are important. If the price makes a lower low, it indicates a potential trend change, but if the price makes a new high, that helps confirm the uptrend. Focus your attention on the support and resistance levels that matter right now. Trends often encounter trouble at strong areas. They may eventually break through, but it often takes time and multiple attempts.

Mark major support and resistance levels on your chart, as they could become relevant again if the price approaches those areas. Delete them once they are no longer relevant—for example, if the price breaks through a strong support or resistance area and continues to move well beyond it.

Also mark the current and relevant minor support and resistance levels on your chart. These will help you analyze the current trends, ranges, and chart patterns. These minor levels lose their relevance quite quickly as new minor support and resistance areas form. Keep drawing the new support and resistance areas, and delete support and resistance lines that are no longer relevant because the price has broken through them.

If you’re day trading, focus on today and don’t get too bogged down with figuring out where support and resistance were on prior days. Trying to look at too much information can easily result in information overload. Pay attention to what is happening now, and mark today’s support and resistance levels as they form.

Trading off support and resistance takes lots of practice. Work on isolating trends, ranges, chart patterns, support, and resistance in a demo account. Then practice taking trades with targets and stop losses. Only once you are profitable for several months with your support and resistance trading method should you consider trading real money.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Trading Opportunities at Recently Created Levels of Support and Resistance

Last Friday’s trading of the EUR/USD didn’t amount to much in the way of trading opportunities setting up at pivot points. Naturally, when the gap between them is large, it carries with it the reality that set-ups along them will be in less abundance. Daily pivot points are truly a favorite method of mine in finding where the turning points in the market may lie. But if the previous day offered a large trading range, then the next day’s pivot points will naturally be spaced wide apart being where they are placed is mathematically determined by yesterday’s open, low, high, and closing price. So you may have to resort to other means to find suitable areas to trade. And that was basically the story of today’s trading.

1. To begin the morning, price fellow below the pivot level before a series of wicks started to test down toward 1.3381. This first occurred on the 3:30 candle, and tests occurred toward 1.3381 on four consecutive candles just before the start of the 4AM (EST) hour. The 4:00 candle broke below, but finished as a doji right along the level.

At this point, I still wasn’t entirely sure whether it would be a worthwhile set-up to consider. The false break below 1.3381 could entail that the market might eventually wish to go there. But there is also something to be said that buyers keep bringing it at or above that level despite all the consecutive tests down there. To me, it seemed like 1.3381 was a balancing point for the EUR/USD before possibly reversing.

When I got a green 4:05 candle, it helped in evidencing the opinion that 1.3381 could hold. So on the 4:10, I let price get down to 1.33808 (where the white line is drawn in the image below) before taking a call option, expecting it to hold at least briefly. It got the hop I was looking for on the 4:15 and I wound up with a good winning trade off a recently created price level.

2. A touch of the pivot level occurred on the 4:35 candle. It held and suggested the pivot could hold for put options and perhaps a channel formation. An immediate re-touch did not happen and fell back down to the 1.3381 level, before a charge back up and above the pivot. This is not an instance where I take the re-touch, especially when it’s covering a good range of distance in one direction in a short period of time. Granted, it had only moved about six pips north in less than ten minutes, but relative to time of day and the fact that it was a Friday, that was actually a notable move. So I decided to pass on this trade.

3. After the break of pivot, the market finally seemed to want to break in the upward direction. It did stall, but the false break on the 4:55 candle suggested more upward movement to come.

A formation of a resistance level did technically form right around 5AM, but given that the market did not return to the pivot point, I didn’t feel there was significant selling pressure to justify a put option there.

A potential trading opportunity did form, however, along the 1.3395 level after the rejection on the 5:50 candle. However, this turned out very similar to the pivot trading set-up that didn’t materialize in discussion point #2. Price fell down from 1.3395 by 4-5 pips, before making a move back up. I was looking for one further rejection of 1.3395 to help validate it as a reasonable area for put options, but that didn’t happen.

The 6:05 candle formed a false break of 1.3395. At this point, I felt it was best to stay out of anything at the white line due to the uptrend and the fact that the 1.3400 whole number and resistance 1 were directly overhead and more realistic targets.

4. The market did touch resistance 1, but no re-touch was in store. The whole number of 1.3400 held quite well as you can tell from the image, but given the test of resistance 1, I felt it was too risky to settle for the whole number as a point of entry for a put option.

Support and Resistance Basics

The concepts of support and resistance are undoubtedly two of the most highly discussed attributes of technical analysis. Part of analyzing chart patterns, these terms are used by traders to refer to price levels on charts that tend to act as barriers, preventing the price of an asset from getting pushed in a certain direction. At first, the explanation and idea behind identifying these levels seem easy, but as you’ll find out, support and resistance can come in various forms, and the concept is more difficult to master than it first appears.

Trading With Support And Resistance

Key Takeaways

  • Technical analysts use support and resistance levels to identify price points on a chart where the probabilities favor a pause or reversal of a prevailing trend.
  • Support occurs where a downtrend is expected to pause due to a concentration of demand.
  • Resistance occurs where an uptrend is expected to pause temporarily, due to a concentration of supply.
  • Market psychology plays a major role as traders and investors remember the past and react to changing conditions to anticipate future market movement.
  • Support and resistance areas can be identified on charts using trendlines and moving averages.

Support and Resistance Defined

Support is a price level where a downtrend can be expected to pause due to a concentration of demand or buying interest. As the price of assets or securities drops, demand for the shares increases, thus forming the support line.   Meanwhile, resistance zones arise due to selling interest when prices have increased.

Once an area or “zone” of support or resistance has been identified, those price levels can serve as potential entry or exit points because, as a price reaches a point of support or resistance, it will do one of two things—bounce back away from the support or resistance level, or violate the price level and continue in its direction—until it hits the next support or resistance level.

The timing of some trades is based on the belief that support and resistance zones will not be broken. Whether the price is halted by the support or resistance level, or it breaks through, traders can “bet” on the direction and can quickly determine if they are correct. If the price moves in the wrong direction, the position can be closed at a small loss. If the price moves in the right direction, however, the move may be substantial.

The Basics

Most experienced traders can share stories about how certain price levels tend to prevent traders from pushing the price of an underlying asset in a certain direction. For example, assume that Jim was holding a position in stock between March and November and that he was expecting the value of the shares to increase.

Let’s imagine that Jim notices that the price fails to get above $39 several times over several months, even though it has gotten very close to moving above that level. In this case, traders would call the price level near $39 a level of resistance. As you can see from the chart below, resistance levels are also regarded as a ceiling because these price levels represent areas where a rally runs out of gas.

Support levels are on the other side of the coin. Support refers to prices on a chart that tend to act as a floor by preventing the price of an asset from being pushed downward. As you can see from the chart below, the ability to identify a level of support can also coincide with a buying opportunity because this is generally the area where market participants see value and start to push prices higher again.

Trendlines

The examples above show a constant level prevents an asset’s price from moving higher or lower. This static barrier is one of the most popular forms of support/resistance, but the price of financial assets generally trends upward or downward, so it is not uncommon to see these price barriers change over time. This is why the concepts of trending and trendlines are important when learning about support and resistance.

When the market is trending to the upside, resistance levels are formed as the price action slows and starts to move back toward the trendline. This occurs as a result of profit-taking or near-term uncertainty for a particular issue or sector. The resulting price action undergoes a “plateau” effect, or a slight drop-off in stock price, creating a short-term top.

Many traders will pay close attention to the price of a security as it falls toward the broader support of the trendline because, historically, this has been an area that has prevented the price of the asset from moving substantially lower. For example, as you can see from the Newmont Mining Corp (NEM) chart below, a trendline can provide support for an asset for several years. In this case, notice how the trendline propped up the price of Newmont’s shares for an extended period of time.

On the other hand, when the market is trending to the downside, traders will watch for a series of declining peaks and will attempt to connect these peaks together with a trendline. When the price approaches the trendline, most traders will watch for the asset to encounter selling pressure and may consider entering a short position because this is an area that has pushed the price downward in the past.

The support/resistance of an identified level, whether discovered with a trendline or through any other method, is deemed to be stronger the more times that the price has historically been unable to move beyond it. Many technical traders will use their identified support and resistance levels to choose strategic entry/exit points because these areas often represent the prices that are the most influential to an asset’s direction. Most traders are confident at these levels in the underlying value of the asset, so the volume generally increases more than usual, making it much more difficult for traders to continue driving the price higher or lower.

Unlike the rational economic actors portrayed by financial models, real human traders and investors are emotional, make cognitive errors, and fall back on heuristics or shortcuts. If people were rational, support and resistance levels wouldn’t work in practice!

Round Numbers

Another common characteristic of support/resistance is that an asset’s price may have a difficult time moving beyond a round number, such as $50 or $100 per share. Most inexperienced traders tend to buy or sell assets when the price is at a whole number because they are more likely to feel that a stock is fairly valued at such levels. Most target prices or stop orders set by either retail investors or large investment banks are placed at round price levels rather than at prices such as $50.06. Because so many orders are placed at the same level, these round numbers tend to act as strong price barriers. If all the clients of an investment bank put in sell orders at a suggested target of, for example, $55, it would take an extreme number of purchases to absorb these sales and, therefore, a level of resistance would be created.

Moving Averages

Most technical traders incorporate the power of various technical indicators, such as moving averages, to aid in predicting future short-term momentum, but these traders never fully realize the ability these tools have for identifying levels of support and resistance. As you can see from the chart below, a moving average is a constantly changing line that smooths out past price data while also allowing the trader to identify support and resistance. Notice how the price of the asset finds support at the moving average when the trend is up, and how it acts as resistance when the trend is down.

Traders can use moving averages in a variety of ways, such as to anticipate moves to the upside when price lines cross above a key moving average, or to exit trades when the price drops below a moving average. Regardless of how the moving average is used, it often creates “automatic” support and resistance levels. Most traders will experiment with different time periods in their moving averages so that they can find the one that works best for this specific task.

Other Indicators

In technical analysis, many indicators have been developed to identify barriers to future price action. These indicators seem complicated at first, and it often takes practice and experience to use them effectively. Regardless of an indicator’s complexity, however, the interpretation of the identified barrier should be consistent to those achieved through simpler methods.

The “golden ratio” used in the Fibonacci sequence, and also observed repeatedly in nature and social structure.

For example, the Fibonacci retracement tool is a favorite among many short-term traders because it clearly identifies levels of potential support/resistance. The reasoning behind how this indicator calculates the various levels of support and resistance is beyond the scope of this article, but notice in Figure 5 how the identified levels (dotted lines) are barriers to the short-term direction of the price.

Measuring the Significance of Zones

Remember how we used the terms “floor” for support and “ceiling” for resistance? Continuing the house analogy, the security can be viewed as a rubber ball that bounces in a room will hit the floor (support) and then rebound off the ceiling (resistance). A ball that continues to bounce between the floor and the ceiling is similar to a trading instrument that is experiencing price consolidation between support and resistance zones.

Now imagine that the ball, in mid-flight, changes to a bowling ball. This extra force, if applied on the way up, will push the ball through the resistance level; on the way down, it will push the ball through the support level. Either way, extra force, or enthusiasm from either the bulls or bears, is needed to break through the support or resistance.

A previous support level will sometimes become a resistance level when the price attempts to move back up, and conversely, a resistance level will become a support level as the price temporarily falls back.

Price charts allow traders and investors to visually identify areas of support and resistance, and they give clues regarding the significance of these price levels. More specifically, they look at:

Number of Touches

The more times the price tests a support or resistance area, the more significant the level becomes. When prices keep bouncing off a support or resistance level, more buyers and sellers notice and will base trading decisions on these levels.

Preceding Price Move

Support and resistance zones are likely to be more significant when they are preceded by steep advances or declines. For example, a fast, steep advance or uptrend will be met with more competition and enthusiasm and may be halted by a more significant resistance level than a slow, steady advance. A slow advance may not attract as much attention. This is a good example of how market psychology drives technical indicators.

Volume at Certain Price Levels

The more buying and selling that has occurred at a particular price level, the stronger the support or resistance level is likely to be. This is because traders and investors remember these price levels and are apt to use them again. When strong activity occurs on high volume and the price drops, a lot of selling will likely occur when price returns to that level, since people are far more comfortable closing out a trade at the breakeven point rather than at a loss.

Support and resistance zones become more significant if the levels have been tested regularly over an extended period of time.

The Bottom Line

Support and resistance levels are one of the key concepts used by technical analysts and form the basis of a wide variety of technical analysis tools. The basics of support and resistance consist of a support level, which can be thought of as the floor under trading prices, and a resistance level, which can be thought of as the ceiling. Prices fall and test the support level, which will either “hold,” and the price will bounce back up, or the support level will be violated, and the price will drop through the support and likely continue lower to the next support level.

While spotting support and resistance levels on a chart is relatively straightforward, some investors dismiss them entirely because the levels are based on past price moves, offering no real information about what will happen in the future.

Determining future levels of support can drastically improve the returns of a short-term investing strategy because it gives traders an accurate picture of what price levels should prop up the price of a given security in the event of a correction. Conversely, foreseeing a level of resistance can be advantageous because this is a price level that could potentially harm a long position, signifying an area where investors have a high willingness to sell the security. As mentioned above, there are several different methods to choose when looking to identify support/resistance, but regardless of the method, the interpretation remains the same—it prevents the price of an underlying asset from moving in a certain direction.

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