Support and resistance is probably the most important part of technical analysis and is the only tool I will look at when stalking trades. Knowing how to qualify levels of support and resistance is crucial to the price action trader, so let’s have a look at some of the methods and tools that can be used to do so.
A price level under the current price that has been respected in the past is called support. A price level above current price that has been respected in the past is called resistance. When price approaches a level of support or resistance, one can generally expect some kind of a reaction, which in many times can, if managed properly, offer a trading opportunity. Typically, when price reaches a significant level of support, buying pressure is often introduced due to the expectancy of a potential bounce or reversal to the upside. When price reaches a significant level of resistance, selling pressure is often introduced due to the expectancy of a bounce or reversal to the downside, sending prices in the opposite direction. Prices often trade in dealing ranges, between significant highs (resistance) and lows (support), and will move above and below these levels through the trading day.
Many tools and methods can be used to define levels of support and resistance, and here are some of those I have found to be most significant and useful in my trading.
If you had to think of a number, would you choose a number like 1.29043 or would you choose 1.2900 instead? I’d probably go for the second number because it’s easy to remember due to its roundness. The notion of round numbers for prices is something we’re all familiar with, just consider your last trip to the supermarket. 10 tomatoes for 2 pounds, a litre of milk for 50 pence, a bottle of your favourite red wine, 8.50 pounds. In any market, round numbers are also respected and often provide a level at which price has a tendency to react. Being able to spot these round number can be very beneficial both when entering and exiting positions.
Consider the following hourly chart in black. The numbers ending with 50 are marked with a dashed line, and numbers ending with 100 are marked with a solid line:
While I rarely use moving averages for anything, there are one or two moving averages that are often referenced by the big banks and thus important to be mindful of. The 200 day moving average is the moving average that I will often add to my charts, as this level is a key reference point, which is often discussed in technical analysis reports. Where is price in reference to the 200 day moving average? is a question you’ll often see being asked by analysts – and when price gets close to this dynamic level of support and resistance, one can generally expect some kind of a reaction.
The following screen-shot illustrates how well price on this hourly chart reacts nicely at the 200 day moving average, marked in red:
This form of support and resistance is formed along a straight line, either sloping or flat. As you can see in the image below, price respects the upper and lower limits of the two trend-lines forming a channel. Once a trend-line has been broken and price has e.g. closed below it, one can generally expect this line/level which once offered support to become a level of resistance as price makes its way lower.
The following screen-shot shows how price moves between the parallel trend-lines on its way up, marked in blue:
Previous period highs, lows, opens and closes
Previous period high, low, open and close levels, be it for the previous hour, four hour, day, week, month or year, are, more times than not, levels at which one can expect price to react. Price often offers a manageable trade when it approaches a previous period (e.g. month, week, day) high, low, open or close, which very often provides nice levels of support and resistance. This is the case, not only when price is approaching these levels, but also when it has moved through them and forms a price correction (rebalance) prior to continuing.
The following screen-shot of an hourly chart illustrates this nicely. The red lines are the previous period lows, the green the highs and the blue the previous day open and close:
There are many other studies that can help qualify key levels of support and resistance, and here is a list of the levels I am mindful of when looking at charts:
- Standard price action support and resistance
- Internal and external Fibonacci retracements and extensions
- Monthly, weekly and daily pivots
- The high, low and open of the Asian range
- Previous period highs, lows, opens, closes and Internal and external Fibonacci retracements and extensions
- 200 day moving average
- Upward and downward channels
For more information regarding how these levels can be used, please consult the strategies category.