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Support & Resistance
The concept of "Support & Resistance" is the foundation in technical analysis of any financial asset. So many trading techniques and strategies are based on this concept. Hence a trader is required to understand this concept thoroughly before going to deep in other aspects of the trading.
Support and resistance are important price levels on the chart at which maximum buying and selling for the security is expected. These are the points where there is a maximum probability of a pause or a reversal of a prevailing trend.
Price is determined by the law of demand and supply. When demand is more than the supply, price tends to rise and when supply is more than the demand, price tends to decline.
What is support ?
When price falls due to an excess of supply over demand, at some lower level price becomes attractive to the sideline buyers to buy. At such level demand starts increasing slowly and price starts rising to the level where it matches the supply. At this point price will stop falling and we call that point as support.
Support can be a single price level or price zone which indicates the buyers' willingness to buy. At this point demand will usually overwhelm supply, causing price decline to halt and reverse. Support level or zone, thus, gives the reference points where the most repetitive buying has occurred in past and is likely to occur again in future.
What is resistance ?
Resistance is the opposite of supply. When price rises due to an excess of demand over supply, at some higher level, the buyers show their reluctance to buy or initiate new positions at such a high valuation. At this point price will stop rising and we call that point as resistance.
Just like support level, resistance can be a single price level or price zone which indicates the sellers' willingness to sell. At this point supply will usually overwhelm demand, causing price rise to halt and reverse. Resistance level gives the reference points where the most repetitive selling has occurred in past and likely to occur again in future.
Support and resistance can be found in all the charting periods; daily, weekly, monthly etc. Some traders observe support and resistance in smaller time frames like one-minute, five-minute, fifteen-minute, half hourly, hourly charts. It should be noted that the longer the time period, the more significant the support and resistance. To identify support and resistance, a trader has to look back at the chart to find out the significant pause in a price decline or rise. Then he should look forward to see whether a price halts and/or reverses as it approaches that level. Sometimes price will dip below support level or reverse back before it gets to the prior support level. The same may happen in case of resistance. Price may reverse before touching the prior resistance level or after breaking above the resistance level. A trader has to develop flexibility in interpreting such chart patterns where support and resistance levels are sometimes referred to as zones.
In short support is a horizontal area on chart where a trader can expect buyers to push the price higher.And resistance is a horizontal area on chart where a trader can expect sellers to push the price lower.
For plotting support and resistance levels, always prefer to use candlestick charts where you can observe open, high, low and close price data easily. A trader is required to identify three or more same extreme low price points from where price turns upward direction more often. Or else he can also identify price zone in which price gets stuck after a down move and then gets reversal. By connecting all these same extreme low price points or zones support level or zone can be plotted easily on a chart.
Similarly a trader is required to identify three or more same extreme high price points from where price turns downward direction more often. Or else he can also identify price zone in which price stuck after an upmove and then gets reversal. By connecting all these same extreme high price points or zones resistance level or zone can be plotted easily on a chart.
Price is a very dynamic concept. Volatility and momentum can affect price movement in significant ways. This is especially true when we look at support and resistance levels in long time frame. Some times spike high or low in price movement makes it difficult to draw support and resistance lines. Professional traders in such cases do their best to kick out the amateurs by letting price spike through levels or make it turn before the actual level. To overcome this shortcoming and improve trading skill, a trader should use ZONES instead of just single lines. Similarly, in a longer time frame during trending mode of the market, a trader may get multiple support and resistance lines or zones too.
Reversal of Support & Resistance
There are unlimited number of indicators and oscillators which are being used or can be used for trading purpose. But no matter whatever indicator you use, price is the single most important factor in calculation of any indicator. That's why it is often said that price itself is the most important and reliable indicator. If you can master the art of understanding price action, you are good to go. However, to understand the price action, the single most important concept to grasp is the "Principle of Polarity". This is the most widely applicable principle in the field of technical analysis.
Principle of Polarity states that whenever support is broken its role is reversed and it begins to act as new resistance. Similarly, when any resistance is broken, it changes its role and tends to act as the new support level for the price. In other words, the former support becomes the new resistance and the former resistance becomes the new support.
Above charts clearly shows how support and resistance levels get reversals.
This happens due to a shift in the quantum of supply and demand. Whenever a resistance level is breached, it is generally because something fundamentally has changed in the market, and the buyers are now willing to pay even more and more price than before and sellers also want to sell at higher prices. This causes the price to rise above the resistance level and pushes it into the new territory.
When the rally cools-off and prices approaches the former resistance (now support), the market participants remember it as an important level. Ideally, if the change was for real, then the price should not break below this level into the older territory. Hence traders and investors starts buying at this level. Also short-sellers who shorted at higher levels now begin to cover their position. All this prevents the price from falling further and causes into shoot once again. This way prior resistance level acts as a support level.
Similarly, a breach of a support level indicates a fundamental change in the market. The buyers are reluctant to buy unless the price falls significantly and the sellers are ready to sell even at lower price. Thus the price keeps falling and making lower lows. When the panic feds and price begins to climb back to former support (now resistance) the market participants remember it as an important level. If there was really any change in the market, then ideally the price should not go back above this level. Considering this, those who bought at the lows, now begin to sell and book their profits. Also, the traders begin to form new short positions. Due to this, the price is unable to rise further and drops once again, thus forming a new resistance at the prior support level.
This Principle of Polarity is easy in understanding, but difficult for mastering. Anyone can understand it, but a few can master it. How to master it..? The answer for it is given by Miguel Ruiz -
"Practice creates the master"
Uptillnow we have seen support and resistance are horizontal areas on our price chart. This is useful when the market is in a range or weak trend. But in strong trending markets, it won’t work well and that’s where we need to rely on dynamic Support and Resistance.
If price action trading is the study of price movements, it also includes the study of trends. Traders can make use of a number of trading techniques to spot and follow price action trends. In fact, price action trading is a game of price making number of highs and lows. Price action traders can follow the sequence of highs and lows strategy to map out emerging trends in the market.
If price movement shows higher highs and higher lows, it indicates upward trend. And if price movement shows lower highs and lower lows, it indicates downward trend. Traders can use their knowledge of sequence of highs and lows to choose as support and resistance levels for trading purpose.
When the price continues to go up and making higher highs and higher lows, then we can plot a trend line on lower band of the upwards sloping formation and consider it as a Rising Support. Similarly, by plotting a trend line on higher band of the upwards sloping formation, we can get a Rising Resistance.
When the price continues to go down and making lower highs and lower lows, then we can plot a trend line on lower band of the downtrend sloping formation and consider it as a Falling Support. Similarly, by plotting at trend line on higher band of the downward sloping formation, we can get a Falling Resistance.
Many a times, traders use both trend lines (Rising Support & Rising Resistance or Falling Support & Falling Resistance) in order to create channels. A channel adds a visual representation of both support and resistance for the time period being analyzed. A single trendline can be look for a spike or a breakout to take price action out the channel. Traders may use that breach as an entry or exit point depending upon their trading set up.
Price Action Trading Strategies
In price action trading, traders use raw price data to analyze and anticipate fure price movement of financial markets. Price action trading strategy is based on logic and simplicity, removing all external noise including news, economics and fundamental data.
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