WHAT ARE SUPPORT AND RESISTANCE, AND HOW DO THEY WORK?

Support: the horizontal area on your charts where potential buying pressure could come in and push the price higher.

Resistance: the horizontal area on your charts where selling pressure could come in and push the price lower.

In short, you can treat support and resistance as areas of value on your charts to help you buy low and sell high.

Support and Resistance Online e-Book Reading

Example of Support

Example of Resistance

Now the question is, how do you draw support and resistance? As you already know, this is subjective, and there are many ways of doing it.

So here are some guidelines I use when drawing support and resistance:

1.   Zoom your charts out so they show at least 300 candles.

2.   Draw the most obvious levels (if you need to second guess yourself, it probably isn’t worth drawing).

3.   Adjust the levels to get as many “touches” as possible.

Examples

THE MORE TIMES SUPPORT OR RESISTANCE ARE TESTED IN A SHORT PERIOD OF TIME, THE WEAKER THEY BECOME

I know this goes against what most trading books teach, but just because something is printed in ink, doesn’t mean it’s correct. Never trust anything and always validate everything, remember?

So here’s my reasoning for telling you this. The market reverses at support because there’s buying pressure to push the price higher. This buying pressure could be from institutions, hedge funds, or banks that have orders to fill around certain price levels.

And when the price re-tests support, some of these orders get filled. So the more the price re-tests support, the more orders get filled. And when all the orders get filled, who’s left to buy?

No one, and that’s when the market breaks down. Here’s what I mean:

SUPPORT AND RESISTANCE ARE AREAS ON YOUR CHART

You might be wondering, “If support and resistance are horizontal areas, why do you draw them as lines?”

I do this because it makes my charts look cleaner and less cluttered, but I treat them as areas on my chart.

“So why is this an area on your chart and not a line?”

This is a result of two groups of traders: traders with the fear of missing out (FOMOs) and traders who want to trade at the best possible price (cheapos). Let me explain.

FOMO traders enter a trade the moment price comes to support because they’re afraid of missing the move. And if there’s enough buying pressure, the price will barely touch support before rallying higher.

On the other hand, cheapo traders only want to trade at the best possible price, and they look to buy at the lows of support. If there are enough traders who behave in this manner, the price will reverse near the lows of support.

But here’s the thing: You have no idea which group of traders are dominant at any one time and whether what you’re seeing is due to the FOMOs or the cheapos. That’s why you want to treat support and resistance as an area on your charts and go in with the expectation that the market could reverse anywhere within the area. Make sense?

WHEN THE PRICE BREAKS SUPPORT, IT COULD BECOME RESISTANCE

When the price breaks below support, that horizontal area could become future resistance.

And when the price breaks above resistance, that horizontal area could become future support.

But why does this happen? Here are a few theories to explain it.

Losing traders want to exit their trade at breakeven

Imagine you bought at support thinking the price would rally higher. The next thing you know, the price collapses and you’re in the red. So, you hope for a rebound to occur so you can exit your trade at breakeven (and there’s no win or loss on the trade). This behavior creates selling pressure at the previous support area. And if there’s enough selling pressure, the price could reverse at the previous support area, which now becomes resistance.

Traders who missed the breakout move

Sometimes the market breaks out so unexpectedly that you miss the move. And you regret your inaction, wishing you had paid more attention to the markets. So what do you do to “tame” that regret? You place a limit order at the breakout price point. If the market ever re-tests the level, you won’t let it get away this time round. For example, if the price breaks out of resistance and traders miss the move, they’ll place a buy limit order at the previous area of resistance (the breakout point). And if there’s enough buying pressure, the price could reverse at the previous resistance area that has now become support.

Self-fulfilling prophecy

Here’s how it works: If enough traders observed a phenomenon and behave in a similar manner, this phenomenon will become true. For example, if the price breaks below support and most traders expect this area of support to act as resistance, then guess what? If there’s enough selling pressure, then this previous area of support now becomes resistance.

But a word of warning: Don’t use the self-fulfilling prophecy as an excuse to apply all sorts of technical analysis to your trading. It doesn’t work that way. Because if you’re going to use something that no one’s ever heard of, you’re likely the only one fulfilling the prophecy. In my opinion, stick to the most popular concepts of technical analysis, because most traders will adopt them one way or another. And when they’re “trapped” by using these tools, that’s where you can exploit the situation to your advantage (but more on that later).

THERE ARE OTHER WAYS TO IDENTIFY AREAS OF VALUE (NOT JUST SUPPORT AND RESISTANCE)

You’ve learned support and resistance are horizontal areas on your chart with potential buying/selling pressure lurking nearby. However, this isn’t the only way to identify areas of value on your chart.

You can also use tools like moving averages, trendlines, channels, and so on to help you identify areas of value.

For example, in a healthy trend (more on this later), the price tends to respect the 50-period moving average and this acts as an area of value. Here’s what I mean:

Alternatively, the market can also respect trendlines. Here’s an example:

Whatever technique you use, the concepts I shared earlier still apply. You’re always dealing with an area on your charts, not a line. And the more times the market re-tests an area within a short period of time, the greater the likelihood it’ll break.

HOW TO TELL WHEN SUPPORT AND RESISTANCE WILL BREAK

There’s no way to tell for sure whether support or resistance will break. But here are a few things you’ll want to pay attention to:

Resistance tends to break in an uptrend — As you know, an uptrend consists of higher highs and lows. And for it to continue, the price must break out of resistance (or swing high).

Support tends to break in a downtrend — Likewise, a downtrend consists of lower highs and lows. And for a downtrend to continue, the price must break out of support (or swing low).

Higher lows into resistance are a sign of strength — This looks something like an ascending triangle. It’s a sign of strength because it tells you buyers are willing to buy at higher prices (despite the price being near resistance). Here’s an example: