Support and resistance also known as supply/demand form one of the basic elements of trading, perhaps only next to price action. Whether you are trading with moving averages or Bollinger bands, chart patterns or Fibonacci levels, the basic reason why prices behave the way they do has got to do with support and resistance levels. Fibonacci aficionados might continue to believe in the ‘magic’ element of the golden number and its derived levels, but as a matter of fact, it is the support and resistance levels behind the price action than indicators or a 38.2% Fib retracement.
This article assumes that the reader already knows what support and resistance levels are. It merely builds upon this information and explores easy to use tips that will definitely help you to trade the support and resistance levels in a better way.
1. The Round Numbers
Starting with the easiest of the lot, round numbers are important support and resistance levels. The 1100’s, 1200’s in gold, 10, 20, 30 levels in silver, the 1.0, 1.50 level in currencies and so on. When prices trade or reach these levels, you can be sure that there will be big sell or buy orders sitting near these levels.
While there is no guarantee that price will strictly reverse upon hitting the round number, it is often seen that prices tend to consolidate around these levels before determining their direction.
The chart below illustrates the various and common price behavior patterns around the round numbers.
2. Support Resistance Flip
A broken support is often tested for resistance and a broken resistance level is often tested for support. When these levels flip over and are tested for the first time and confirmed by price, they are strong levels to trade off from. A support or a resistance level is usually broken by strong price action. The momentum led rally or decline first breaks the immediate support or resistance level, rallies or falls a bit further away and comes back to test the broken levels.
An obvious but often overlooked aspect on the Support/Resistance flip is that the retest of the broken level needs to occur after price has rallied a significant level. The above chart, is a perfect textbook example, which shows the broken resistance being retested for support after a strong continuation.
You can further look for validation at these levels by means of candlestick patterns as well as indicators. The same chart above is now shown with the Stochastics oscillator, which shows a bullish divergence with the current lows in prices not being confirmed by the Stochastics.
3. Tell tale signs of a confirmation
One of the common questions asked by traders is how does one know when a support or a resistance level has held. This is actually simple.
Support Confirmation: Price establishes support, then rallies then dips back but doesn’t test the support level but instead it makes a higher low
Resistance Confirmation: Price establishes resistance, then falls only to pull back but doesn’t test the resistance level but instead price makes a lower high
An important point about support/resistance confirmation is that these take place within a few bars after a level has been established and makes it easier to scalp the short term markets.
4. Candlestick patterns and round numbers
This tip works best on the daily time frame and combines both candlestick patterns and the round numbers. In order to understand where prices will move next, simply plot a few round numbers above and below the current price. Once you notice a reversal pattern such as a bullish or bearish engulfing or a shooting star and so on, you can be sure that price action most likely will move to the next nearest round number. The chart below shows round numbers and the up and down arrows near candlestick reversal patterns. Pay attention to how price behaves after the pattern is confirmed.
5. The Golden Rule of Support and Resistance
So far we have seen some different ways to trade with support and resistance. But this is the most important rule of all that many traders tend to miss out. Support and Resistance levels do not guarantee that prices will reverse. They simply show price levels where the probability of a reversal in price is high. But don’t confuse probability for certainty, they are two different things.
When trading with support and resistance levels, always have an If Then plan.
If Support holds
then buy to the next resistance
if Support fails
then know where to exit