There are numerous ways to locate support and resistance levels on the chart. We will cover them in this article and also examine the characteristics of these levels and what it means if the price moves beyond a support or resistance level (they get “broken”).
SUPPORT AND RESISTANCE ESSENTIALS:
- Support levels are price zones with many buy orders, while resistance levels have many sell orders.
- A support level predicts a level below which the price will not fall.
- A resistance level anticipates a barrier above which the price will not break.
- An “s/r flip” (support/resistance flip) happens when a support level is broken and becomes a resistance level or vice versa.
- Support and resistance levels can be identified by using horizontal lines, trendlines, moving averages, Fibonacci tools, Ichimouku cloud, among others.
Support and resistance levels
Supports are price levels with a high amount of buy orders. The price has difficulty falling past these levels; it usually rebounds there. This makes support levels great trade entry points. If the price falls beyond a support level – this is referred to as the level getting broken –, a bigger decrease in price usually follows. Traders often place stop-loss orders below support, as this means that, if the support gets broken, the trade will not result in a significant loss if the price keeps falling.
Resistances are price levels with a high amount of sell orders. Due to the heavy sell pressure at these levels, the price has difficulty climbing above them. Resistance levels are therefore great trade exit points. When a resistance gets broken, a surge in price often happens.
Characteristics of support and resistance levels
When talking about support and resistance levels, one must acknowledge that these are not exact price levels. They can vary up to a few percent. It is also not uncommon that a price bursts through support or resistance for a short period of time and returns back soon after (this is called a “retrace”).
As it is expected that these levels will hold, the general rule is to buy at support and sell at resistance. However, support and resistance can get broken, so it is important to know how to evaluate their strength.
The strength of support and resistance levels is determined by the amount of buy and sell orders concentrated around their area. The bigger the amount, the stronger they are.
Their strength can also be determined by observing price behavior when it reaches these levels. A strong price bounce off support or resistance implies great strength. Support and resistance levels gain in importance every time the price rebounds from them – the more, the better.
When a support level gets broken it becomes a resistance level. The opposite is also true; when a resistance is broken it becomes a support. This is called a support/resistance flip or “s/r flip” for short. If a certain price level experiences a s/r flip several times, it is deemed as an extremely important level on the chart.
As with most indicators, higher time-frames tend to be more reliable. Therefore, support and resistance levels found on higher time frames are stronger than those found on lower time frames.
Identifying support and resistance levels
We have covered the basic characteristics of support and resistance levels. Now it is time to focus on how to locate them. The prime tools for the job are horizontal lines and trendlines. However, there are also other indicators and tools which serve the same purpose. They are described below.
Horizontal support and resistance lines
As the name suggests, horizontal lines are drawn on the chart horizontally and represent a particular price level (say, 5000 USD). They can be drawn on the chart to see how the price has reacted to a particular level and to predict how it may react in the future. Some price levels have significant importance for psychological reasons (round, and sometimes large, numbers) or technical analysis reasons based on past price action around these levels.
To find a price level where a meaningful horizontal line can be drawn, a trader has to spot where on the chart the price has bounced off the same levels multiple times; or in other words, figure out which levels represent a significant barrier for the price. When an asset is trading above the drawn line, it acts as a support, and when it is below the line, it acts as a resistance.
Often the wicks of candlesticks cross horizontal lines for a short period of time, although the candle closure still happens above or below the line (above when it comes to support and below when it comes to resistance lines). These occasions increase the strength and validity of support or resistance levels of a horizontal line.
Trendlines are drawn on the chart diagonally. As opposed to horizontal lines, a single trendline does not represent constant price level. They are used to identify support and resistance levels when the market is in an uptrend or downtrend and therefore represent ascending or descending price levels.
To draw a trendline correctly, it has to connect at least two candlestick tops or lows. If it connects more of them, the trendline is deemed stronger and more valid. If a trendline connects candlestick lows, it acts as support and if it connects candlestick tops, it acts as resistance. When a trendline is broken, a support trendline becomes a resistance trendline and vice-versa.
Moving averages are lagging technical indicators which smooth out past price movement. They also represent the location of support and resistance levels. If the price is above the moving average it acts as support and if the price is below the moving average it acts as resistance. The long-term moving average support and resistance levels are usually stronger than the short-term ones.
As the Bollinger Bands indicator includes a moving average in the middle, it can also be used to determine where the wanted levels are.
Fibonacci retracement and extension levels are also extremely useful to identify support and resistance. The difference with this tool is that a single Fibonacci retracement or extension provides many potential support and resistance levels.
One of the primary use cases of Ichimoku cloud is also spotting these levels. As with Fibonacci, there are more different supports and resistances that this indicator is capable of determining.
Utilizing support and resistance levels can be rewarding and should therefore be a part of every trader’s arsenal. In combination with other indicators and tools, they become a powerful means of achieving desired results in trading.