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Support and resistance indicators in trading

Education /
Desmond Leong

What is support?

Support refers to a general price zone where there is significant buying interest that could halt or reverse a downward price movement. This concept in technical analysis is based on the historical observation that prices tend to stop falling and begin rising upon reaching these zones.

Support is crucial for traders as it indicates areas where market sentiment is likely to shift from bearish to bullish. It is not a precise price point but rather a range where traders anticipate potential upward momentum. Understanding support helps traders make strategic decisions, such as where to consider entering buy trades or placing stop-loss orders to manage risk effectively.

 

What is resistance?

Resistance refers to a broad price zone where an upward price movement encounters significant selling pressure, making it difficult for the price to climb further. This concept is vital in technical analysis, as it highlights areas where market sentiment is likely to shift from bullish to bearish. Resistance is not a specific price point but rather a range where traders anticipate potential downward momentum.

Recognising resistance zones helps traders make strategic decisions, such as identifying where to potentially enter sell trades or place stop-loss orders on long positions. Understanding the concept of resistance is essential for developing comprehensive trading strategies and for making informed decisions about trade management.

 

What are support levels?

Support levels in trading are specific price points within the broader support zones where the buying pressure is historically proven to be strong enough to prevent the price from declining further. These are precise values on a price chart, identified through past price actions, where the price has consistently rebounded after touching these levels.

Support levels serve as key indicators for traders, signalling potential points for market reversal or stabilisation. They often lead to a bounceback or at least a pause in the downward trend. Distinct types of support levels, such as horizontal lines, trendline intersections, or Fibonacci retracement levels, offer varying degrees of predictive strength and are used by traders to pinpoint more exact entry or exit points in the market.

 

What are resistance levels?

Resistance levels in trading are specific price points within the broader resistance zones. These are precise values on the price chart, identified through historical analysis, where prices have repeatedly failed to rise further. Resistance levels act as clear indicators for potential market reversals or pauses in an uptrend. They are crucial for traders because they represent the exact points where selling pressure has historically been strong enough to overcome buying pressure, leading to a price drop or stabilisation.

Distinct types of resistance levels, such as horizontal lines, trendline intersections, or Fibonacci retracement levels, offer varying degrees of predictive accuracy. Traders use these specific levels to pinpoint more exact entry or exit points in their trading strategies, enhancing the precision of their market analysis.

 

Support and resistance zones

Support and resistance zones, also known as areas, are key levels on a price chart in technical analysis that indicate significant buying or selling pressure. These zones play a crucial role in identifying potential price reversals and breakouts.

Zones encompass wider ranges within which multiple support or resistance levels are concentrated, unlike traditional support and resistance levels, which are precise price levels that can be easily determined.

The importance of support and resistance zones lies in their ability to provide traders with a more comprehensive understanding of market dynamics and price patterns. Traders use these zones to gauge the strength of buying or selling pressure, determine entry and exit points, and identify potential profit targets.

The concept of support and resistance zones differs from individual support and resistance levels as it considers the market's psychology and potential accumulation or distribution areas. By considering these broader areas, traders can better anticipate price reactions and make more informed trading decisions.

 

How to identify support and resistance

When it comes to identifying support and resistance levels in trading, there are several key factors traders should consider. Firstly, it is important to look out for price levels that have historically acted as barriers or pivot points. These levels can indicate areas where buyers or sellers have previously shown significant interest. Traders can identify these levels by analysing previous highs and lows on a price chart.

Example of Swing Highs and Lows:

Another way to identify support and resistance is through the use of trendlines. Trendlines are drawn by connecting two or more consecutive highs or lows. These lines can then act as potential support or resistance levels in the future.

Example of a Trendline Resistance:

Example of a Trendline Support:

Additionally, traders should pay attention to key psychological levels, such as round numbers or important Fibonacci levels. These levels often attract attention from market participants and can serve as strong support or resistance areas.

Volume and price patterns also play a crucial role in identifying support and resistance levels. A surge in trading volume near a specific price level can indicate strong support or resistance. Similarly, price patterns like double tops or double bottoms can signal potential levels where support or resistance may be found.

Overall, identifying support and resistance levels requires a combination of technical analysis tools and an understanding of market psychology.

 

How to trade support and resistance

Traders can trade support and resistance levels in several ways. One common strategy is to buy when the price approaches a strong support level and sell when it reaches a well-established resistance level. This approach allows traders to take advantage of potential price reversals.

Additionally, some traders may choose to place stop-loss orders slightly below the support level or above the resistance level to minimise potential losses. Another strategy is to wait for a breakout, where the price significantly moves above a resistance level or below a support level, indicating a potential trend continuation. In this case, traders can enter trades in the direction of the breakout, aiming to profit from the sustained momentum. Implementing these strategies with careful analysis and risk management can enhance a trader's ability to profit from support and resistance levels effectively.

 

Advantages of support and resistance

Support and resistance offer several advantages to traders and investors. Firstly, support levels provide a floor or a lower boundary for the price of an asset, indicating a point where demand is strong enough to prevent further price declines. By identifying and monitoring these support levels, traders can make more informed decisions on when to enter or exit positions, helping to minimise losses and maximise profits. On the other hand, resistance levels act as a ceiling or an upper boundary, indicating a point where supply is strong enough to prevent further price increases.

Recognising and tracking these resistance levels can help traders determine when it may be a suitable time to sell or take profits. Additionally, support and resistance levels can act as psychological markers, with many market participants placing buy or sell orders around these key levels. This can result in increased trading activity and liquidity, leading to more accurate price moves and improved trade execution. Overall, understanding and applying support and resistance analysis can provide traders with a valuable tool to navigate market trends and enhance their trading strategies.

 

Disadvantages of support and resistance

One drawback of using support and resistance levels in trading is that they are subjective and open to interpretation. Traders may have different opinions on where these levels lie, leading to inconsistency in their analysis. Secondly, support and resistance levels are not foolproof indicators. They are based on historical price data and assume that the market will continue to react in an analogous manner in the future. However, market dynamics can change, rendering these levels ineffective.

Additionally, support and resistance levels can sometimes act as self-fulfilling prophecies, causing many traders to buy or sell at these levels, resulting in crowded trades and potential price manipulation. Lastly, support and resistance levels may not work well in choppy or highly volatile markets where price swings are unpredictable and frequent. Therefore, it is important for traders to use additional indicators and analysis methods to complement support and resistance levels and make more informed trading decisions.

 

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The images shown are for illustration purposes only. The data is sourced from third-party providers. The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your personal objectives, financial situation, or needs into account. Readers should seek their own advice. Past performance is not indicative of future results, and any forecasts about future performance may not occur.



Desmond Leong

Desmond Leong

Desmond Leong runs an award-winning research team (2019, 2020, 2021 Finalists for Best FX Research and Best Equity Research) advising the largest banks and brokers on where the markets are heading. He specialises in technical analysis with a focus on Fibonacci, chaos theory, correlations, market structure, and Elliott Wave.

Desmond is incredibly passionate about helping people become better traders - working closely with Axi to produce educational videos, quizzes, e-books, indicators, and market research to help traders take their game to the next level. His team is also behind the Axi VIP portal, dedicated to continuing to guide and educate traders.

Find him on: LinkedIn | Instagram


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