An introduction to support and resistance basics. Support and resistance are technical analysis concepts which form the foundation for many trading strategies and other technical analysis methods.
Support Level Basics
Support levels are points where the price had a hard time pushing down through in the past. In other words, a support level is a level where a price stops falling. Often support can be found at slightly different levels. For example, the price moves down to $90 in the morning, later in the day it goes down to $89.90 before moving higher, then near the end of the day the price touches $89.95 before moving back up to close at $91.
In this example 3 support levels are created, but together they form a support area. Support areas are more significant than a single level because it shows the market tried several times to breakthrough that region, but couldn’t sustain it. In this case the support area would be $89.90 to $90.00.
Figure 1 shows an example of a support area. Notice how the price moves to a similar area over and over again, and appears to bounce off it. This is support, because it shows buyers are willing to step in (or sellers back off) at that price area and push the price back up.
Figure 1. Support Area on USDJPY Daily Chart
Resistance Level Basics
Resistance levels mark areas where the price couldn’t rally through. In other words, a resistance level is where a price stops rising. Resistance levels also form resistance areas. If a stock rises to $90 then declines, rises to $90.10 then declines, rises to $90.05 and declines, the trader knows $90 to $90.10 is providing resistance.
Figure 2. Resistance Area on AUDUSD Daily Chart
Resistance and Support Areas
Resistance and support levels are dynamic, meaning the price may edge past the old support resistance level, only to reverse course shortly after. This new price is a new resistance or support level, but should be coupled with old support and resistance levels in the same area to create a support or resistance area.
Support and Resistance Breakouts & False Breakouts
Support or resistance breakouts occur when the price moves through a support or resistance level/area. For instance, if a stock has moved up to $100 repeatedly, but can’t break above that price, $100 is a resistance level. When the price finally moves above $100 it’s a breakout. When the price moves to a resistance or support level, but doesn’t break through, it’s called a test (the level was tested).
Figure 2 shows support and resistance areas, followed by a breakout. The price breaks strongly through support, and continues to move lower, showing that support for the stock (at that support level) is no longer there.
If the price moves quickly back the other way through the support/resistance zone it just broke out of, it’s called a false breakout. In the example above, if the stock moves above resistance at $100, that’s a breakout, but if it falls back below $100 shortly after and proceeds lower, that’s a false breakout. See Effective and Simple Forex Strategies for a strategy to capitalize false breakouts.
Strength of Support and Resistance
By using support and resistance areas (when available), instead of just a single level, we have a better chance of picking levels to watch that have more significance. The more times a price area has been tested, but not moved through significantly, the more important and stronger that price area is. For example, if the price is in uptrend, reaches 1.20 and then declines, that is not particular important. If the price reaches 1.20 two or three times and can’t get through, that is significant. The reason is that during an uptrend we expect the price to make new highs, thus moving above old highs. During a downtrend we expect the price make new lows, thus moving below old lows. Usually the more times an area has been tested, with no significant breakout, the stronger the breakout when one eventually develops.
The strength of support or resistance can also be determined by the strength of the reaction off of it. Any area that reverses a trend can be considered strong. When the price comes back to test this area we can expect that some support/resistance will be provided in the vicinity of this reversal point. This doesn’t mean the price will always stop at that level again, but the area should be given some respect by the trader.
Figure 3. Strong Resistance Created by a Reversal
Diagonal S&R (trendlines)
There is also diagonal support and resistance levels, which change over time. The lines, or areas, of support and resistance are called trendlines (See: How to Use Trendlines For Trading – Dispelling the Myths). To create an uptrend trendline, connect the low points during an overall rise in price. To create a downtrend trendline, connect the high points during the overall decline in prices. Trendlines show where traders are stepping in to stop the price from rising or falling. The actual support/resistance levels associated with a trendline are always changing since the trendline is sloped.
Figure 3. AUD/USD Hourly Chart
I used trendlines extensively in my day trading and swing trading. Check out Day Trading Stocks or Forex in 2 Hours or Less, to see some ideas on how you can incorporate support and resistance into you trading.
Support and Resistance – Final Word
Support and resistance occur on all time frames. These levels can be seen on a one minute chart, which may only show a few hours of price action, or a weekly chart which shows years worth of data. If multiple time frames show resistance at a certain level, that level is likely very significant, for all traders. Even a day trader can benefit if a breakout occurs on a weekly chart. A longer term trader may not be aware of why a major move occurred intra-day, but it could be because strong support or resistance levels were broken on a shorter-term chart/time frame.
Not all time frames need to be analyzed, but it is a good idea for all traders to look at time frames longer than the one they currently trade on, to be aware of larger forces (support and resistance) that may be at work. If longer term traders are looking to enter or exit, and want a good price, it may be worth looking at shorter time frame charts and noting where the price could stall at support or resistance.
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