Support and Resistance
Support and resistance are the most important yet the most overlooked topic of trading. You can be consistently profitable in trading only if you understand the behavior of the market i.e.if you knew what the market is going to do next. Understanding support and resistance can bring an immense change in your trading and will provide you with a proper understanding of the market. In this article, we will find out what support and resistance actually is and how are support and resistance formed in the most straightforward way possible.
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.
There is a straightforward fact about price action, price action acts based on the historical data and history often repeats itself. Support and Resistance are those areas in any particular chart which traders believe to have significant importance based on historical data. Support and resistance are those areas where the price reverses back.
For example –
The market is up-trending, that 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 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 strongly 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 and thinks the price will reverse from this point which causes the momentum change from buyers to sellers, i.e., more traders are now 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 every time when 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 actually formed, let us try to understand it on a more technical level.
For this let’s take an example of GBP-JPY 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 was rallying upward, it reached to 148.86 level and strongly reversed back. From this point, the buyers lost the momentum and sellers took over the control of the market. From this point, the price strongly 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 a significance of this level and believes that the price will reverse from here onwards and 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 reverse 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 good 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.
In the next article, we will try to comprehend some more aspects of support and resistance, and I will tell you what happens when either of these levels is broken.