What is support and resistance
Support and resistance is at the core of most trading strategies. Numerous studies of successful spread bet traders have found that most just use simple support and resistance to underpin where and when they take a trade. Support and resistance is at the core of all trading in our Live Trade Room.
A support or resistance price level is formed when a market’s price action reverses and changes direction, leaving behind a peak or trough in the market. Support and resistance levels are horizontal price levels that typically connect price bar highs to other price bar highs or lows to lows, forming horizontal levels on a price chart. These change points are called swing points. Price will often respect the support and resistance levels and they tend to contain price movement until price breaks through them.
Support and resistance levels are also known as supply and demand levels. But what exactly is supply and demand?
Supply is an area on a chart where sellers are likely going to overwhelm buyers causing the stop to go down. On a chart we call this resistance.
Demand is an area on the chart where buyers are likely going to overwhelm sellers causing the stock to go up. On a chart we call this support. generally, therefore, it makes sense to buy at support and sell at resistance.
Buyers will continue to buy at support and will do so until they believe the fundamentals of the market have changed. It is not unusual to see price move up from a support level a number of times.
Sellers will continue to sell at resistance and will do so until they believe the fundamentals of the market have changed. It is not unusual to see price from a resistance level a number of times.
When price action is moving up and down between a support and a resistance level, the market is known as ranging. A breach of a support and resistance level, known as a breakout, signifies a change in the supply and demand.
On a move up through a resistance level buyers are now prepared to pay more than previously. Some of the sellers in the market, like the idea of a higher price and stop selling in the hope of getting a better price later. And with less sellers in the market, the in-balance between supply and demand means the market moves higher. The dynamics of the market have changed, and both buyers and sellers reassess their understanding of the market and will often change their buy or sell strategy.
On a move down through a support level sellers are now prepared to accept less than previously. Some of the buyers in the market, like the idea of a lower price and stop buying in the hope of getting a better price later. And with less buyers in the market, the in balance between supply and demand means the market moves lower. The dynamics of the market have changed, and both buyers and sellers reassess their understanding the market and will often change their buy or sell strategy.
Support turns to resistance
The role reversal feature of support and resistance level is a little understood concept by beginner traders. In essence, a strong support or resistance level once breached, may change its role from support to resistance or resistance to support. There are numerous suggested reasons for this role, and it is possibly to the new psychological dynamics of the market following the breach. The easiest way to start to understand support and resistance is simply to look at charts.
Plotting support and resistance
Some beginner traders will plot support and resistance levels on every timeframe that they can find. And although the support and resistance levels may not in themselves be wrong, a significant number of support and resistance levels can make trading decisions difficult.
At Trade Room Plus we primarily plot key support and resistance from swing points on the daily timeframe and the one-hour timeframe. We don’t generally consider support and resistance levels that show themselves on shorter timeframes only. The key support and resistance levels can be seen on all timeframes. We are not, however restricted to trading the levels only on the timeframe that they have come from. A key level plotted on a daily time frame will be a good trading point on a 5 minute chart.
As a rule of thumb, a high swing point, signifying a resistance level is a high bar/candle with two or more lower bars/candles either side. A low swing point, signifying a resistance level is a low bar/candle with two or more higher bars/candles on either side.
Tips for plotting support and resistance
The best support and resistance levels are always the most obvious. Ideally you want to trade levels that many other traders and institutions around the world want to trade as well.
- Less is more, only plot significant levels
- Consider all support and resistance levels as zones rather than exact prices
- Keep it simple and un-cluttered
- Mainly use daily timeframe plus some one-hour timeframe
Example of using daily support and resistance levels for trading on Gold 5 min chart
The 5 minute chart across shows simple price action with previous support and resistance levels plotted on the daily timeframe. These gave a good number of trading opportunities over one day.