What is support and resistance?
Let us begin with understanding what support and resistance are, and then we will follow in further and interpret it correctly.
In a down-trending market, support is a price level from where buyers entered the market and restricted the price from going any lower. In an up-trending market, resistance is a price level where sellers entered the market and restricted the price from going any higher.
These two are the purest definitions of support and resistance and the simplest to understand.
How does support and resistance work?
There is a straightforward fact about price action, price action acts based on historical data, and history often repeats itself. Support and resistance are those areas in any particular chart which traders believe in having significant importance based on historical data. Support and resistance are those areas where the price reverses back.
For example, the market is up-trending, which means buyers are in control and are causing the price to rise higher. Now, at a level, the price suddenly reverses as too many traders are selling or willing to sell. This indicates that buyers lost their control over the market, and the momentum shifted towards the sellers. This level or area, where the price stopped and reversed back is called the resistance. This area from where the price reversed for the very first time will hold a level of importance in the mind of the traders who observed this reversal.
Now, the price continued moving in a downward direction after the reversal and got to a level from which it again rose and tried challenging the earlier level from which it initially reversed. The traders who initially saw the reversal holds the importance of this level in their minds. And as the market reversed back sharply from this point the last time, many traders will try to sell from this level, which will again cause the momentum to shift from buyers to sellers. What happens here is, more traders now holds the importance of that level. The traders think the price will reverse from this point, which causes the momentum change from buyers to sellers.
Now more traders are willing to sell, and this makes buyers lose control of the market, and the price drops from that level. So the level from which the price is falling is now the resistance. And the level from which the price is rising is the support level. Every time the price reaches the resistance level and fails to penetrate it, traders sell. And whenever the price reaches the support level and fails to penetrate it, traders buy. These levels get more strong and significant; the more times the price fails to penetrate it.
Now, as you have understood how support and resistance works or how it is formed, let us try to understand it on a more technical level.
For this let’s take an example of GBPJPY pair
From the starting of this year(2019), this pair is rallying upward. This pair is in an up-trending market, i.e., buyers are in control of the market. The price moved to 148.00-149.00 level in the last two months. As the pair were rallying upward, it reached to 148.86 level and sharply reversed back. From this point, the buyers lost momentum, and sellers took over the control of the market. From this point, the price sharply reversed and dropped to 143.72 level.
Now, at this point, the exhausted buyers again stepped in tried to push the price higher. While driving the price higher, the price reached a level from which it reversed earlier. So, what happens here is, the buyers who saw a reversal from this point holds the significance of this level. They believe that price will reverse from here onwards, so a large number of trader now sells from this level, which causes the momentum to shift from buyers to sellers and hence take the price down again.
This level (148.86) from which the price reverses back(goes down) is now a resistance level and the level(143.72) from which the price rises, is the support level.
The more times the price tries and fails to get past those levels, the stronger and significant these level gets for the traders. Just like wine, support and resistance get much better with time. The more time those levels are tested, the better it gets.
Different people have different ideas about support and resistance. Many people often get confused understanding this topic because people have a habit of ignoring simple things and trying to learn it the complicated way. Support and resistance is a crucial yet straightforward aspect of trading.
Try to understand what the price is telling you, and you will be able to do excellent finding support and resistance zones. And even better in trading because the price action is the outcome of what the majority of traders do. And this will most likely help you understand the mindset of other traders, which is a critical factor in trading.
Now let us try to comprehend some more aspects of support and resistance, and let’s see what happens when either of these levels is broken.
What happens when support or resistance levels are broken?
Above, we learned about the basic support and resistance. We saw how support and resistance forms and also learned about the psychology behind support and resistance. We hope you have understood the psychology behind it clearly because a trader needs to understand what is going on in the market. You can’t rely on the lines, patterns, or an indicator to get into a trade. A great trader understands every aspect of the trade he is about to enter.
Now, what happens if any of those support and resistance zones are broken? Does support become resistance and vice versa? When the price breaks the support level, it turns into new resistance. And when the price breaks a resistance level, it turns into new support. We will tell you the exact psychology behind it.
In the above example, we saw the price was ranging between support and resistance zones. Consider if the price breaks any of the zones, the question arises, why did the price break that level which seemed very important till now? What happened that made the price to break that level? Let us try to understand this more clearly.
Consider the price bounced back from the support area, being reversed from the support area the price moves towards the overhead resistance. Now the sellers, who sold from this area earlier, holds a significance of this level in their minds. And hence enters a sell trade from this area or nearby this zone.
This time the price does not reverse from that resistance zone and penetrates right through it. The only reason that the price did not reverse from this area is that this time, the buyers were active. Buyers thought there is too much potential upwards and continued buying right through the resistance level. Hence there was no momentum change from buyers to sellers, and buyers continued to control the market. Now the traders who sold here had to deal with a losing trade.
The traders who used stop loss eventually get stopped by the price and those who didn’t use stop loss is in grief and regret. The traders who used stop loss takes a small loss, and the other ones get into a drawdown, they both are now in pain of losing the trade. Now, after penetrating through the resistance zone, the price rallied upwards for a few days and reached a level from which it again reverted to the previous resistance level.
So, how will the traders who saw a betrayal of the market at this point react to this?
1. The traders who closed the trade taking small losses is not going sell at this point again, as they had a losing trade at this point. Meaning that the momentum of the market is still with the buyers, i.e., buyers are still control of the market.
2. The traders who did not close their trade and were in drawdown is now thankful that the price finally came down. And they will close the trade as soon as it gets nearby their resistance zone to save their money. Now, these traders will most likely be away from this trade.
What happens here is that now, more sellers exit the trade, and the buyers are most likely to control the market. It causes an increase in the hold of buyers, and hence, no momentum change from buyers to sellers is observed. Due to these two situations, there is an increase in the hold of buyers towards the market. So it causes the price to move even higher, and thus the previous resistance now acts as a support. Hence resistance becomes support.
The above situation is explained using a diagram below.
Now, let us try to understand this using an example from the real forex market. For this, let us take an example from GBPJPY.
As you can see, the price was trapped between a range caused by support and resistance zones, as shown in the image below. Every time the price got into those zones, it got strongly reversed. Now, after several attempts to break past any of the zones, the price finally penetrated through the support zone and moved past that level. Let us understand the psychology behind this.
What moves the price past this level? The lack of momentum shift from sellers to buyers caused the price to penetrate through the support level. The sellers kept on selling as they saw more potential to the downside and hence kept the control of the market, which caused the price to penetrate through the support area.
Now, after penetrating through the support zone, there can be two types of traders who took a loss at this point.
1. Those who used stop loss and got out of trade taking a small loss.
2. Those who waited for the price to reverse and are still in drawdown.
Both types of traders placed a buy trade at the support level as it holds vital importance in their mind. But the price penetrated through the support zone and the buyers lost this trade. Now let us see what happens with the traders who got out with a small loss.
The traders who closed the trade taking small losses is not to going sell at this point again, as they had a losing trade at this point. Meaning that the momentum of the market is still with the sellers, i.e., sellers still are in control of the market.
Now after a few days, the price again reverses back from a point and moves back to the previous support zone. Now let us see what happens to the sellers who were in a drawdown. The traders who did not close their trade and were in drawdown is now thankful that the price finally came up. Those traders close the trade as soon as it gets nearby their resistance zone to save their money, and these traders will most likely be away from this trade.
So, these two situations caused the increase in momentum of sellers and buyers lost the control to sellers. Now, this level acted as resistance and hence the price again moved lower from this level.
Hence, old support becomes resistance, and old resistance becomes support.
How to determine if support or resistance has been broken or not?
There are various ways by which we can confirm if a support or resistance level is broken.
1. Draw support and resistance as a zone
Always consider support and resistance as a zone. We always tell this to our students, support and resistance is not a line, it is always a level or zone. If you can understand this aspect of support and resistance, it will be effortless for you to determine if the support and resistance are broken or not.
If you have a total understanding of support and resistance, then you can draw it effortlessly and correctly. And if you can draw it accurately, then it will be easy for you to spot a breakout effectively.
2. Wait for price to close above or below the zone
According to our experience in forex, support and resistance levels are broken when the price has a successful close above the zone(In case of resistance) or below the zone(in case of resistance).
3. Wait for the price to retest
If you are a beginner in forex trading, then you can wait for the price to retest your support and resistance zone as this can provide you an extra confirmation.
4. Mention the time frame
When drawing support and resistance zones, make sure you mention the timeframe they are drawn on. Because if you draw a support and resistance zone considering a monthly timeframe, then you should look for a break of that zone on the monthly time frame. Because if you consider the break of zone based on weekly timeframe then maybe it is just a fakeout and the price will get rejected from that level after some time. So, if you draw a support and resistance zone on monthly time frame then look for a breakout on monthly timeframe itself. And if you draw it on daily timeframe then look for a break on daily timeframe itself.
How to identify whether the support or resistance will hold or break?
Trading is the game of probabilities, the sooner you understand this, the better it will be for you. You cannot be a hundred percent accurate in forex trading. But you can increase your chances of winning if you have a proper understanding of the market and if you can read the market correctly.
1. Support and resistance gets stronger with the number of times price touches it, but also remember that support and resistance are meant to be broken
The more the number of touches, the more valuable that area becomes and the more accurate your support and resistance zone is. Because the number of times the price challenged that area and got rejected tells you that price is respecting that area. But this does not mean that it will not break. So, be prepared for both scenarios.
2. While trading support and resistance always look who is controlling the market
If the market momentum is with buyers, and if the price is in the buyer’s zone, then no matter how strong the level seems to you, it can be broken by the price.
3. Check if the price is rejecting from your support or resistance zones
Because if the price is rejecting, then that means the price is respecting the level, and it is most likely, that the support resistance area will hold.
Support and resistance if used with the proper information, can make any forex strategy profitable. We ourselves use support and resistance while we do our analysis, and we can tell you one thing from experience that support and resistance can do wonders to your trading.