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.
Support and Resistance
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 these 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 aspect of the 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
In finance, a trend line is a bounding line for the price movement of a security. It is formed when a diagonal line can be drawn between a minimum of three or more price pivot points. A line can be drawn between any two points, but it does not qualify as a trend line until tested.
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 view 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 because 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 it retreats from the level a number of times before doing so.
Trading Based on Support and Resistance
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. 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.
Most traders consider waiting for some confirmation entries that the market will respect.
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 consolidation near the resistance area, and 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 of cents, ticks, or pips below the consolidation when buying. When selling, the stop loss goes a couple of 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.
Old support can become new resistance or vice versa. This isn’t always the case, but it does tend to work well in very specific conditions, such as a second chance breakout.
Conclusion
Support and resistance levels are important for all traders, regardless of their timeframes.
The only difference between long-term and short-term charts is that longer-term support and resistance levels are more likely to hold than ones that form on shorter-term charts, so traders should pay more attention to long-term levels.
