The concept of support and resistance is beyond the paradigm of chart patterns, indicators or even the technical analysis. It is the classic case of supply and demand acting at specific price points. But are they bound to remain the same ever, at the exact spot?
Let’s visit the basics first, before delving deeper into the subject for your answer.
Support and Resistance
Support is the area in which maximum demand for an asset class exists. The buyers outnumber the sellers in the support areas.
On the flip side, the area which has maximum supply is the resistance. Likewise, sellers outnumber buyers in resistance.
The general trading convention is to expect the support and resistance to hold rather than break.
The psychology behind support and resistance
Take, for instance, in a downtrend, as the price of an asset decreases, the demand for it increases.
At some point, the bulls come in numbers to grab the asset owing to cheaper valuation.
The bears who shorted the asset at a higher price also book profits.
If the latter is the reason, the trend pauses temporarily, but if it is the former, then the trend reverses altogether. But both the points are ‘support’.
Likewise, the points at which an uptrend makes a temporary pause or a permanent reversal is the resistance.
Fundamentally, the support and resistance are the points at which investors feel an asset is either overvalued or undervalued, based on which demand or supply varies too.
(New to forex? Confused about whether to follow fundamental or technical analysis? Get to know the #9 key differences between Fundamental & Technical Analysis)
How to identify support and resistance?
There are two types of support and resistance: static and dynamic.
Static: Remains the same, historically, and play out always.
Dynamic: Subject to change often, subject to price action, depending on multiple factors.
The spotting of static ones is pretty easy as compared to the dynamic ones.
Traders tend to rely on support and resistance indicators to identify the dynamic ones.
Historical price action
When a trend reverses from a specific point three or more times, historically, traders expect it to hold rather than break.
Hence, traders use it as a reference point to either enter or exit their trades.
The number of reversing times, and whether the points paved temporary or permanent course change are the critical factors in assessing the strength of support/resistance.
In the above chart, you can see that the value of 0.89200 proves to be a tough nut to crack by the sellers. Each time it touches the point, the demand for the pair rises which in turn raises the price.
The round numbers are a psychological benchmark for a trader.
For instance, if a stock touches $100 or $1000 for the first time, the buyers tend to take their foot off the gas. It makes the traders think twice before hopping in.
Also, some dilute their positions to protect their profits.
So the multiples of 10s, 100s and 1000s, have a trivial effect in stocks and commodities and act as a zone of profit booking and a temporary pullback (mostly) ensues. Whether the asset chooses 10s, 50s or 100s as its intermediate milestone is subject to its volatility.
Forex trading does have round numbers in the form of ‘00’ levels.
Also, retail traders and newbies mostly fixate to round numbers as their entry point or a target. Though their volume is small, it still has its effect.
The effect of round numbers usually plays a more significant role at the all-time highs and lows, when traders have no historical reference.
Round numbers are the lighthouse of traders when they are in untested waters. During January 2019 flash crash, all the currency pairs plunged against Yen. GBP/JPY plummeted heavily taking it into a price range which was an unfamiliar zone even to the experts.
And so traders resorted to the round numbers. Every time the price hit a round number, doubts crept in resulting a temporary pullback. The value of 131 only made traders come to their senses putting an end to the bloodbath.
Moral: If you are in unchartered territory, look for the round numbers.
The trendline is one of the best indicators of static support and resistance.
A slanting line which connects the higher lows in an uptrend and the lower highs in case of a downtrend is the trendline.
It slightly differs from the usual support and resistance since it identifies resumption of a trend after a short-term pullback rather than trend reversal points.
For instance, in an uptrend, after making new highs, the market retreats due to profit booking. The buyers who couldn’t get hold previous time, and who long to go long, use the trendline support as the reference point to initiate a fresh position.
Hence, demand soars at the trendline. As a result, the asset surges, yet again.
The above chart is an excellent example of the impact of the trendline. The initial rally of gold commences with a trendline. Each time it hits the trendline, bulls utilize it as a buying opportunity.
After a while, it notches up the momentum and creates a new trendline, which is even steeper. It marks the demand surge in the market and acts as a confidence booster to the bulls. If one line fails, the other comes to the rescue of bulls too.
The tricky part with the trendline, which many noobs get it wrong, is that it is deemed to hold rather than break. This mind hack lets you leverage the trendline 4 out of 5 times.
Support and Resistance Zone
Theoretically, support and resistance should be the same static points without any whipsaws around it.
But, is it possible for millions of traders around the world to accept one point as their ‘messiah’ for trend reversal and to converge in numbers at that point?
Opinion differs from person to person and traders are no different.
The recent chart studies reveal that traders converge aplenty in a zone rather than a point. And the area is known as the support and resistance zone.
These zones usually act as accumulation for buyers or sellers and it tends to prolong for a more extended period.
As a result, it ensues a stronger rally or a huge sell-off, more often than not.
The chart shows the area of 1.0200 acted as a strong resistance, initially. However, with each subsequent rally, the bears seem to appear sooner, at 1.01000, than earlier occasions. An aggressive trader might even have the opinion that anywhere above 1.0000 is a selling opportunity in the counter.
It’s just different minds having different opinions about the valuation or some get access to a piece of news sooner rather than later. But, the eventuality remains the same.
Also, it’s the case of late – zones becoming more relevant than a lone value.
Role reversal of support and resistance
Support and resistance do hold most of the times, but when they do break, two events surface.
One, it provides a spectacular trade opportunity since the traders who expected it to hold are caught off guard. So they are forced to cover their positions. Then, if the new trend persists for some time, they hop into the trade. So it invites an avalanche of buyers (if resistance is broke) into the setup.
Next, the broken point reverses its role — if a support breaks, it becomes resistance and if a resistance breaks, it converts itself to support. It, in turn, provides a buy on the dip, or sell on rally scenario.
In the above chart of GBP/JPY, the zone of 146 seems to be a critical level. It is a round number as well as price action. But once it breaks, it rallies back to test the breakout in both the cases.
The follow-through rally is also intense and steep in both scenarios, courtesy – ‘testing part’, which acts as a confirmation of the breakout and traders tend to pounce on such opportunities.
Support and Resistance Indicators
Though the support and resistance is a rudimentary concept, there’s much more to it than meets the eye.
Most advanced trading concepts are formulated only to identify the supply and demand zone, especially dynamic, in the market which in turn is a support and resistance zone.
The indicators which render the dynamic supports and resistances of the market are the support and resistance indicators. Moving average, Fibonacci ratios, Pivot points, Murray math lines and Williams Fractals are the best examples of support and resistance indicators.
Like trendlines, moving averages are also excellent support and resistance indicators.
Most traders use moving averages, either simple or exponential for their trade decisions.
Traders buy an asset when it crosses a moving average, say 100 SMA and sell when it breaks.
Therefore, they act as supply and demand zone which in turn provides support and resistance to the market.
It is important to note that moving average too acts as a zone rather than as a point.
Take a look at the example above, the moving average acting mimicking a trendline. The 100 SMA and 200 SMA of higher time-frames tend to lend a helping to traders in trend moves. Get to have a deeper insight on moving average – SMA and EMA – the here. Is it the oldest trick or golden ticket?
The relationship between Fibonacci and humans ages back centuries. If you’re wondering, traders are humans too, although they seem too cold at times.
Irrational emotional decisions always align with a Fibonacci ratio or the Fibonacci ratios just happens to be at the right place at the right time.
Anyhow, it acts as an indicator of the dynamic support and resistance and helps out the traders.
When an asset retreats during a trend move, it finds support or resistance at the 38.2%, 50% or at the 61.8% retracement of the preceding move.
Once, it crosses the previous high (or low), the Fibonacci extensions, say 1.272, 1.414, 1.618 or 2.618, acts as resistance (or as support).
As you can see in the above chart, the price initially falls only to retrace and take resistance at precisely the 50% level.
It resumes its downward move and as it reaches the 1.618 extension level, traders tend to book out profits which acts as minor support. The minor support once taken down becomes a resistance indicating its importance.
The above two indicators are for positional players but day traders also have a say in the market.
Pivot is the best indicator of intraday support and resistance. It denotes where the demand and supply for the day exists.
Come the next day, the points seem irrelevant. So, it is strictly for day trading.
As per the methodology, if the asset crosses the pivot from below, the trend for the day is bullish. Suppose, it breaks below, then the trend is bearish.
An intraday trader anticipates a move to the support or resistance depending on the bullish or bearish trend.
The S1, S2, R1, R2 values provide the intraday supports and resistances.
See the above chart, since the price opens above the pivot point 1.32936, it moves to the R1 1.33255.
But unable to sustain higher levels, the pair plunge and broke the pivot point for the day which creates a negative sentiment.
The bears pile up ensuing a significant sell-off and take down the S1 of 1.32681. The S1 then acts as a resistance to nudge it down to S2.
An intraday trader uses any one of the breakouts to initiate a position for the day and close it out at the next level, calling it a day.
Positional trading with pivot points
What started out as an intraday venture, now extrapolated by many for positional trading too.
Traders use OHLC of weeks and months and generate pivot points for their positional trading.
Forex traders even use pivot points for each session for scalping or intraday trading.
(Get to know the importance of sessions and best timing to trade forex here.)
Murray math Lines
Murray math Line is similar to Pivot point, but it addresses a critical problem left unattended by Pivot point.
The pivot points do not convey whether a support or resistance line is set to hold or break. So, a trader decides with his premonition and uses pivot point just a reference point, which demands expertise.
Whereas, Murray Math Line renders what to expect from each level it defines.
Moreover, it applies to any time frame and over any period.
The levels to watch out for 0/8,4/8 and 8/8.
0/8 and 8/8 are the extremes. The logic is to assume these levels to hold, but if they capitulate, then the Murray Math lines expand to form a new series of levels.
4/8 is the pivot level, which defines a trend change.
Metatrader 5 do provide it as a free indicator.
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Fractals belong to the package of Williams Indicator. Though it is often construed as an indicator, it is actually a chart pattern.
The fractals pattern is legible to a naked eye if one is acclimatized to the market.
It is a chart pattern with five or more candles. The successful formation of a pattern acts as a support and resistance indicator.
There are two types of fractals.
Bearish Fractal – Higher high candle is in the middle accompanied by lower high candles on either side.
Bullish Fractal – Lower Low candle is in the middle accompanied by two higher low on either side.
The indicator has a low success rate when used solitarily, but upon teaming up with, alligator renders better performance.
As you can see in the above chart, fractals indicator identifies even the slightest of a pullback.
There are many instances in which it could have trapped you, especially the bear fractals.
However, if you are using it towards the trend, only to buy on dips, the bull fractal would have been a handy tool. So, like always in technical analysis, perception matters.
The concept of support and resistance is the fundamental aspect of technical analysis. One needs to have a better understanding or even attempt to identify it with innovative ways to have any success in trading, especially via technical analysis.
Even the fundamental analysts, who detest technical analysis do use support and resistance indicators for the entry point and partial profit bookings.