What is support and resistance?
I am sure some of you are adept to the concept of support and resistance, but still let’s have a revision. Support and resistance is a value area on the price charts at which the price had an abrupt movement in the past.
When price approaches these value areas again in the future trading sessions, you can expect the price to behave a bit different and these areas do have influence on the price movement.
For instance, you open the chart of the GPBUSD currency pair and you observe that at one point on the chart the price shot up suddenly and the movement was strong compared to the price movement prior to that.
Now, you wait for the price to revisit this particular price level again and you observe that price bounced from it and went up again.
Congratulations, you have managed to spot a strong support price level on the GBPUSD chart and you can mark this and keep it under your radar if price revisits this level again in the coming trading sessions.
Same is the case with resistance price levels. If the price tanked and declined sharply from a price level and when price revisits this level again and it again tanked, you have a strong resistance at hand.
So, a support is a level where buyers find the price cheap and they look to go long and resistance is a level where sellers find the price expensive and they go short. I hope you have developed some idea about support and resistance levels now and we will carry forward this and understand why exactly these levels work the way they do.
What is the rationale behind the support and resistance levels?
Before I move on with this, I want to first put forward a hypothetical scenario before you. Let’s suppose that you are driving on a highway at a fast speed and you are cruising on the round listening to your favorite music in your car.
While you are driving, you see a small turn ahead but you also see a car coming from the other direction and if you take the turn then you might ram into the other car. What would you do in this situation? You would either let your car crash into the other car or you might do something else to save that car and crash your car into the road divider.
God forbid that this happens to any of you because it happened to me and trust me it wasn’t a good time in my life. In that moment I decided to save the other car from any damage even though he did nothing wrong and I turned my car in the opposite direction and the tires gave out and my car rolled 3-4 times.
Now, what do we learn from such an experience? Yes, you guessed it right that we should not drive at such high speeds. But, when you hear about such incidents or if you have experienced them first hand, you will develop this instinct in you of automatically getting cautious whenever you approach that particular area.
You do so because you know that there is a turn ahead or maybe the road ahead isn’t good or even maybe the road is wet and you might not be able to turn properly. You will instantly slow down and drive with care and get past that part of the road and then maybe increase the speed of the car again.
You might be thinking that how is this relevant in trading and I completely get it. Traders that participate in the financial markets are humans after all with basic human tendencies. When a trader is trading and is screening the charts and sees that at a particular price level on the chart the price either tanked or sky rocketed, then he would become a bit cautious.
Why would traders do so? It is because they don’t know whether price will behave the same way it did earlier but what do know is that there are market participants present at such levels and are ready to do something.
Market psychology around the support and resistance levels
When a market is in an uptrend, it is clear that the buyers are in complete control. What happens when the market reverses from a particular level? It means that the momentum has shifted and now the sellers have gained control.
When the price was moving higher, there will be traders that take long trades expecting the price to rise even further, only to see that they bought just before a reversal. This particular instance hurts their pockets as they incurred a loss on the trade and now for them this particular price level from where the price reversed, has some significance now.
After the reversal, the price is moving down and market participants are joining the trade and taking short trades at various price levels. What will happen if price sees a bullish momentum and it gets to the price level from where the reversal took place?
The market participants that booked losses the last time will now start selling at this price level in order to make a profit on this trade and cover their losses. This has a trickle-down effect and more and more sellers enter the market and the price declines again from this level.
Will price always reverse from a support and resistance level?
Short and quick answer, no not always.
You should understand that the financial markets run on human psychology and sentiment. When a large number of traders hold the bias that the price should go higher, then the price might just go higher if the buyers outnumber the sellers. Even if you see a 1 second chart and see that the price declined, then it means that in that span of a second, seller outnumbered the buyers.
Coming to the part of support and resistance, when a large number of market participants know that there is a value area present at a particular location on the chart and if they hold the bias that price should respect that level then a support will act as support and resistance will act as resistance.
Again, it depends on what the sentiment is. If price approaches a resistance level and the sellers take action and start selling aggressively and over power the buyers, then the price will decline sharply. But, if the sellers do not have the adequate strength to overpower the buyers, then no matter how strong the resistance level was, it will get breached.
Most effective way to trade support and resistance
1. Stop believing in rules that don’t make sense
I have read this on quite a few trading forums and also many traders say this that the more the support or resistance level is tested by the price the stronger it gets. What this means is that if you have a support level and if price has multiple times approached it bounced away from it, the stronger the level becomes.
I want you to not fall for such claims. Yes, this theory might work at times, but it is not the right way to put it.
Like I mentioned above, the markets function on human psychology and sentiment of the market participants. If the majority of the market participants are having a bullish bias, then the price will move up, and vice versa.
Rules like, multiple touches to the support or resistance level makes it stronger, tries to make this business of trading certain. You might hear traders saying that trade a support or resistance level only if there have been 3+ price touches.
Price will not always act that way. If you follow such rules, you might end up missing quality trades but would’ve capitalized only if you stopped staying so certain and adapting to what the market does.
In trading, nothing is certain and you should make peace with this. Things aren’t going to work exactly how you thought or planned it would. You have to think in terms of probabilities and you need to devise a plan that will allow you to leverage your edge and capitalize on these probabilities.
2. Support and resistance is a zone and not a line
I am very sure that quite a lot of you mark the support and resistance levels as mere lines on the charts. If you don’t, then I am sure that when you were a beginner, you started out by plotting these levels as simple lines.
I don’t blame you for it, the all information that is fed to us is what leads to this wrong practice.
I strongly want you to stop doing this and start plotting the support and resistance levels as zones, mark them by creating a rectangle around the area on the charts.
You won’t believe but since I started doing this, I have literally changed trading for myself. I’ll tell you how. So when we mark the support and resistance as lines, we only have a reference of that single line on the price charts.
So whenever price approaches the level, it will either bounce away from it or will break it, we take trades accordingly and we place our stop loss just below or above the line according to the trade taken. Now, it is just a line and what happens is that price hovers around the line and it keeps triggering stop losses.
It happened to me quite a lot of time and the losses that I had to incur was getting on my nerves because the price would literally hit my take profit after kicking me out of the trade. So, I don’t know what hit me one particular day, I started marking these support and resistance levels as zones.
I would spot a support or resistance line on the price charts and then would take the rectangle tool and plot a rectangle around it taking into consideration all the wicks and past price movement. Long story cut short, I started staying in the trades for longer as small price movements did not trigger my stop loss.
If I am taking a short trade, then my entry will be at the lower end of the rectangle and stop loss would be above the upper end of the rectangle, or the zone. My hit rate started increasing as I was staying in trades and not getting kicked out. My account started growing as I started incurring less losses. This small tweak has done wonders in trading for me and I wanted to share this secret with you too and want you to take complete advantage of it.
How do you trade support and resistance?
I would like to know how you trade support and resistance and whether you have any distinct strategy to approach this concept.
I want you to go on to the charts and apply all that I have discussed in this blog post and don’t forget to let me know if it made any difference for you.
Share this blog post with every trader you know and let them also know this secret and transform trading for themselves.
You can always reach out to me through the comments section and I make sure to get to back to every one of you.