Support and Resistance Part 2
In the last article, 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. I hope you guys understood the psychology behind it clearly because it is essential for a trader 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?
In this article, I will tell you the exact psychology behind it.
Now, in the previous article, 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 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 and they 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 one gets 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 closes 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.
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. Moreover, the new level from which the price reversed this time is the new resistance level. Hence resistance becomes support.
The above situation is explained using a diagram below. (Support and Resistance)
Now, let us try to understand this using an example from the real forex market.
For this let us take an example from GBP-JPY.
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 and closes 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.