To use support and resistance effectively, you must first understand how asset prices typically move, in order to interpret support and resistance from that framework. You should also keep in mind that there are different types of support and resistance, such as minor and major/strong. The lower levels are expected to break, while strong levels are more likely to stay and make the price move in the other direction.
Support and resistance are highlighted with horizontal or angled lines, called trend lines. If the price stops and is reversed in the same price area on two different occasions in a row, a horizontal line is drawn to show that the market is struggling to pass 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 ups and downs during a trend. Then extend that line to the right to see where the price might find support or resistance in the future.
These simple lines highlight trends, ranges, and other chart patterns. They provide traders with a vision of how the market is currently moving and what it could do in the future.
2. Major and Minor Support and Resistance Levels
The lower levels of support and resistance are not maintained. For example, if the price tends to fall, it will make a minimum, then it will bounce and then begin to fall again. That low can be marked as a smaller support area as the price stagnated and bounced at that level. But since the trend is low, the price is likely to fall through that lower level of support without much trouble.
The areas of least support or resistance provide analytical information and possible business opportunities. In the previous example, if the price falls below the lower support level, then we know that the downtrend remains intact. But if the price stops and bounces at or near the previous low, then a range could develop. If the price stops and bounces above the previous minimum, then we have a higher minimum and that is an indication of a possible trend change.
The main areas of support and resistance are the price levels that have recently caused a change in trend. If the price had an upward trend and then invested in a downtrend, the price where the reversal took place is a strong level of resistance. Where a downtrend ends and an uptrend begins is a strong level of support.
When the price returns to an important support or resistance area, you will often have difficulty crossing it and going back in the other direction. For example, if the price falls to a strong support level, it will often bounce up. The price may eventually break it, but generally, the price is removed from the level several times before doing so.
3. Trading Based on Support and Resistance
The basic trading method for using support and resistance is to buy near support in bullish trends or parts of ranges or chart patterns where prices are rising and sell/sell short near resistance in bearish trends or parts of ranges and chart patterns where prices are falling.
It helps isolate a longer-term trend, even when trading a range or a graphic pattern. The trend provides guidance on the direction to negotiate. For example, if the trend is low but then a range develops, preference should be given to short selling with range resistance rather than buying with range support. The downtrend lets us know that going short has a greater chance of generating profits than buying. If the trend is up and then a triangle pattern develops, favor buying near the triangle pattern support.
Buying near the support or selling near the resistance can bear fruit, but there is no guarantee that the support or resistance will remain. Therefore, consider waiting for some confirmation that the market still respects that area.
If you buy near the support, wait for consolidation in the support area and then buy when the price exceeds the maximum of that small consolidation area. When the price makes a move like that, it lets us know that the price continues to respect the support area and also that the price is starting to move higher outside the support. The same concept applies to sell in resistance. Expect a consolidation near the resistance area, then enter a short trade when the price falls below the minimum of the small consolidation.
When buying, place a stop loss several cents (or ticks or pips) under the stand, and when shorted, place a stop loss several cents, ticks or nuggets above the resistance.
If you are 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 an operation, keep in mind a target price for a profitable exit. If you buy near the stand, consider leaving just before the price reaches a strong resistance level. If the short in the resistance, leave just before the price reaches strong support. It can also go to lower levels of support and resistance. For example, if you are buying on support on an upward trend channel, consider selling at the top of the channel.
In some cases, you may be able to make more profits if you let a break happen, instead of selling with less support/resistance. For example, if you are buying near triangle support within a larger uptrend, you may want to keep trading until you break the resistance of the triangle and continue with the uptrend.
There is also the concept that old support can become a new resistance or vice versa. This is not always the case, but it tends to work well in very specific conditions, such as a second chance break.