Technical analysis is seductive and many traders spend way too much time studying the whole array of methods available. The issue is that there is much more to successful trading (such as fundamental analysis, trade management and position sizing ) so instead of cluttering your trading screens with esoteric techniques of limited value, seek to simplify your chart reading.
The benefit is twofold:
Your decision making process is simplified;
You can devote more time to the other components of trading.
In this article we’re going to discuss one of the simplest technical observations available, which continues to withstand the test of time: Support and Resistance.
Support and Resistance
Any tool we place on our charts should help us make sense of the apparent randomness of market movements. Support and resistance levels are quite useful in this context because they give us a clear context.
Without getting overly complex, support and resistance levels are key prices the market gravitates towards and bounces off – and they can create high risk:reward trading opportunities because as a trader, you know exactly when you’re wrong and should exit the trade.
Support is a key level that is below the current price.
Whereas resistance is a key level that is above the current price.
Of course, do not blindly expect support and resistance levels to hold all the time. Moreover, trading is not about being right every time. It is about stacking the odds in your favour each time you risk your money in the market so your profits are, on average, larger than your losses. This way you don’t need to win all the time!
How to Identify Support and Resistance Levels
Identifying support and resistance levels is part art and part science. Different traders will look at the same chart, and often see different things.
In saying that, it is generally best to stick to the most evident support and resistance levels that stick out like a sore thumb, because those levels will likely attract decent participation.
Notice also that trading support and resistance is not about pip-perfect touches or rebounds. More realistically, you should view support and resistance as an area that can extend 15-30 pips (sometimes more) around the actual level.
Support and resistance levels for long and short term traders
No matter if you plan to be a day trader or long-term trader, you should identify support and resistance levels from the larger timeframes first. For example, identifying clear levels from a Daily chart, and cascading them down the timeframes onto your trading timeframe is usually a better solution than trying to trade all the smaller support and resistance levels from the micro timeframes.
For example, let’s use the levels from GbpUsd above and see how the market reacted in the recent past on the smaller timeframes. Here is the hourly chart, viewing the market’s reaction around the same level. Do you see any potentially useful price action patterns that could have assisted you in preparing a high odds trade at the level?
But we can also drill down further to a 15min frame, attempting to plan our trades from the same levels.
Swapping roles: Support turns into resistance (and vice versa)
One characteristic of support and resistance levels is that often enough, support turns into resistance and vice versa.
This is because the levels gain psychological significance. Once they become important, they remain that way for some time, even after the level has been breached.
How to trade using support and resistance levels
Support and resistance levels can be traded in two ways:
- You can trade the reversal off a support or resistance on the initial approach.
- You can trade the breakout/pullback to the level, once the level is clearly breached.
To trade a break, you wait for the price to move through the level and then enter in the direction of the trend.
Keep it simple
Learn to use support and resistance levels in your trading in a step by step fashion.
Start by plotting the evident support & resistance levels from the Daily chart. Next, drill down to your trading timeframe and be patience. Wait until price transacts the level and wait for appropriate setups.
And finally, don’t forget to have a plan to limit your risk if the trade does go against you.