Support and resistance! This is a price level where the price of a commodity may be expected to pause due to a concentration of demand or buying interest.
In this article, we will be discussing trading support and resistance which will enlighten you on why and how essential it is for every trader to understand how to find/identify support and resistance levels.
Table of Contents
- What are support and resistance?
- What is support?
- What is resistance?
- Trading based on support and resistance
- Use of trend-lines in finding support and resistance
- Do support and resistance really work?
According to the law of supply and demand as the price of assets or securities drops, demand for the assets or securities increases, thus resulting in the support level.
What are support and resistance?
The terms support and resistance are applicable to the financial world, this is the idea of buying and selling stage. It is definitely two of the most quite discussed attributes of technical analysis, a Part of analyzing chart patterns used in trading commodities, stock, etc.
These terms are used by traders to refer to fee levels on charts that tend to act as barriers, stopping the rate of an asset or commodity from getting pushed in a sure direction
What is support?
Support as the name implies takes place when falling prices of a commodity hit a certain level and then stop thus bouncing off the level which may result in consolidation or a reversal ( change in direction).
If the price of a commodity trades at a support level, traders might expect the commodity to change direction where it starts to rise depending on the strength of the trend. support is often viewed as a “floor” which is supporting, or maintaining prices.
Once an area or “zone” of support or resistance has been identified, price levels can serve as potential entry or exit points for traders and investors because, as a price reaches a point of support or resistance, it will do one of two things which could be to —bounce off from the support or resistance level, or violate the price level and continue in its initial direction —until it hits the next S&R level ( This may be a result of economic data release which serves as a catalyst on the direction of assets and commodities)
The timing of some trades is based totally on the trust that S&R zones will not be broken. Whether the rate is halted with the aid of the support or resistance level, or it breaks through, traders can “bet” on the path and can rapidly decide if they are correct.
If the price moves in the incorrect direction, the position can be closed at a small loss with the help of a stop order placed a few pips below their entry point. If the commodity, security, or stock move in their speculated direction, the cross may also be substantial.
What is resistance?
Resistance in finance is a charge level where rising commodity/expenses stop, alternate or change direction, and then start to fall. Resistance is often viewed as a “ceiling” retaining commodities/expenses from rising higher.
If a trend breaks the guide or resistance level, the rate often continues to the subsequent degree of support or resistance. S&R level/points are not always exact, often time they are typically a sector protecting a small range of prices so ranges can be breached, or penetrated, besides always being broken.
As a result of that, traders make use of support/resistance ranges to help pick out feasible points where rates might also alternate directions.
Support level – Area on your chart with potential buying pressure
Resistance Level – Area on your chart with potential selling pressure
Furthermore don’t be disappointed if the Support & Resistance levels/lines haven’t worked for you until now. You see, in reality, S&R is price zones, not exact numbers, and is not set to stone.
This is clearly visible when switching from a higher time frame to a lower one, it can be a horizontal line on a weekly chart and perfectly be made by a horizontal price channel on a one-hour chart.
This is why it often appears to be a break of a support or resistance level by just the commodity price testing it. These ‘tests’ of support and resistance are usually represented by the candlestick shadows piercing the Support & Resistance levels.
If the market were made by S&R lines and not by traders, then the exchange rate would always rise and fall to the same exact price points more often than not.
But because that rarely happens it’s important to think of support and resistance as zones on the chart where traders/ investors anticipate buying (go long) and selling (go short) on a commodity, stocks, etc.
One way to induce the habit of Support & Resistance lines as zones are by drawing them with the help of a line chart, avoiding a fine-point trace. That way you won’t fool yourself into believing you have identified the exact price at which a currency pair or commodity price is going to test, bounce off, and start moving in the opposite direction.
To often draw better lines, especially the horizontal ones, use two lines, an upper one (resistance) and a lower one(Support), or use rectangles clarification to mark the zones. You may find and make use of all the necessary tools on your trading platform.
Trading based on support and resistance
The basic trading method for using support and resistance levels is basically to buy when a commodity/stock trades into the support zone in up-trends or the parts of ranges and chart patterns where prices are moving up, and then sell(go short) near or when a commodity/stock price trades into the resistance zone in downtrends or the parts of ranges and chart patterns where prices are moving down.
Use of trend-lines in finding support and resistance
S&R is highlighted with horizontal, sloppy, or angled lines called trend lines. 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 or break that area.
In an uptrend, the price makes higher highs and higher lows. In a downtrend, the price makes lower lows and lower highs.
During an uptrend 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.
In a downtrend, connect the lower highs using a falling sloppy line. Then extend that line out to the right to see where the price may potentially find support or resistance in the future.
Do support and resistance really work?
Support and resistance work because people have feelings and memories. If that sounds confusing, here’s an example that should put things in perspective.
Let’s say you’re planning to sell pizzas.
When people want to buy pizza, they have an expected price range in their minds. Depending on the location, quality, and brand, they are willing to buy a pizza anywhere between $8.99 and $15.99.
But, what if your pizza is really excellent and you want to charge $29.99?
Getting 30 bucks for a pizza sounds fantastic, but it’s so overpriced that there would be no buyers.
Now, what happens if you offered your pizza for $1.99?
People probably wouldn’t believe that you are a legitimate seller, but even if they did, you would be crazy to sell for such a small amount of money. There are costs to cover, not to mention that you want to make money at the end of the day.
The current price range of $8.99 – $15.99 is a temporary consensus between buyers and sellers about the worth of a pizza. For that money, pizza makers feel they’re getting paid and people feel they’re paying a fair price.
Translated into trading language, the $8.99 and $15.99 act as support and resistance. These are psychological barriers, that prevent the price of the asset from getting pushed in a particular direction.
The more times S&R is tested, the weaker it becomes, S&R are areas on your chart where traders intend to buy or sell a commodity pair (and not lines). Don’t place your stop loss just below Support or above Resistance as it might be raided by market liquidity.
Trading when a price hits the S&R level gives traders/ Investors a favorable risk-to-reward ratio, Additionally, an S&R can be implemented as a trading strategy.
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