Support and Resistance

What Are Support and Resistance?

The price of financial assets is determined by forces of demand and supply, just like in any other trading market. In financial markets, it is support and resistance levels that accurately illustrate how the supply and demand forces interact to determine the prevailing price of an underlying asset. Prices usually rise until the supply outstrips demand and that is the point of resistance, where prices will start going down. Similarly, prices will fall until demand outstrips supply and that is the point of support, where prices will start going up.

The basic strategy in the market is to buy an asset when prices are at the support level and to sell when prices are at the resistance level.

It is important to note that support and resistance levels are not exact price points, but rather zones where demand and supply can change. Support and resistance levels are closely monitored by market participants, who are all keen to take advantage of opportunities that may arise when supply or demand changes.

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Types of Support and Resistance

Fixed

These are support and resistance levels that are fixed and cannot change. They will only be invalidated if prices manage to break above or below them. Psychological and sentimental levels, such as round numbers or previous important price points (such as all-time highs and lows), are examples of fixed support and resistance levels. For instance, in stocks, round numbers, such as $100, can provide support or resistance to an asset price. While commodities trading, rates such as $2,000 for the gold price can be considered a support or resistance level.

Dynamic

As the name suggests, these are support and resistance levels that change as the price and time change. These levels imply that prices are subject to new forces of demand and supply. Technical indicators, such as Moving Averages and Bollinger Bands, create dynamic support and resistance levels as the price and time change.

Semi-Dynamic

Semi-dynamic support and resistance levels also change as time and price change, but they change at a fixed or predetermined rate. Some of the indicators that plot semi-dynamic support and resistance lines are Trendlines, Fibonacci Tool, and Pivot Points. These indicators plot support and resistance lines that change methodically as time and price change.

How to Find Support and Resistance Levels

Here are some of the ways to find support and resistance levels in the markets:

• Peaks and Troughs
  This is the most straightforward way of plotting support and resistance levels. Simply mark visible highs and lows on your chart; the higher highs and lower highs will serve as resistance levels, whereas the lower lows and higher lows will serve as support levels. It is always recommended that these lines are marked on longer timeframes to have reliable support and resistance levels.

• Fibonacci Levels
  The Fibonacci indicator can be used in two ways: Fibonacci retracements help traders identify the best entry points when a trending market is retracing; whereas Fibonacci extensions help traders identify the most optimal target points of a trending market. In an uptrend, Fibonacci retracement lines will act as support lines, whereas in a downtrend, they will act as resistance lines. On the other hand, Fibonacci extension lines will act as resistance lines in an uptrend, and support lines in a downtrend.

• Pivot Points
  The Pivot Points indicator uses the open, high, low and closing prices to mathematically derive multiple lines that serve as support and resistance levels in the market. The indicator plots 7 lines: 1 pivot point (PP), 3 support lines (S1, S2 and S3), and 3 resistance lines (R1, R2 and R3). If a support line is breached, it turns into a resistance line, and vice versa. For instance, if there is an uptrend and the asset price breaches R1, the line will now act as support.

• Trendlines
  Trendlines form the foundation of technical analysis and can help traders trade with the trend. In an uptrend, a trendline is drawn from one particular low, connecting other higher lows and projecting the line into the future. The line then acts as a semi-dynamic support line.

In a downtrend, a trendline is drawn from one particular high, connecting subsequent lower highs and projecting the line into the future. The line then acts as a semi-dynamic resistance line.

How to Trade with Support and Resistance

Here are some of the online trading strategies using support and resistance levels:

Range Trading Strategies

A ranging market, also known as a sideways market, occurs when the price of an asset oscillates between well-defined support and resistance levels without showing a clear long-term upward or downward trend. Traders can capitalise on these oscillations by buying at support levels and selling at resistance levels. To enhance the reliability of these trades, other technical indicators can be used to confirm entry and exit signals.

Below, we’ll outline a simple trading strategy suitable for beginners and then delve into a more sophisticated variant for seasoned traders.

Simple Range Trading Strategy for Beginner Traders

Objective: Buy low at support levels and sell high at resistance levels within a ranging market, using basic technical indicators for confirmation.

Identify the Range

• Support Level – Find the price level where the asset consistently stops falling and bounces back up. This is the support level.
• Resistance Level – Identify the price level where the asset repeatedly stops rising and reverses downward. This is the resistance level.

Confirm the Range

• Use a time frame suitable for your trading style (e.g., 1-hour or 4-hour charts for short-term trading).
• Ensure that the price has touched both the support and resistance levels at least twice to confirm the validity of the range.

Use a Confirming Indicator

• Relative Strength Index (RSI) – A momentum oscillator that measures the speed and change of price movements, ranging from 0 to 100.
  • Oversold Condition (Buy Signal) – An RSI below 30 suggests the asset is oversold.
  • Overbought Condition (Sell Signal) – RSI above 70 indicates the asset is overbought.

Set Entry Points

• Buying at Support:
  • Wait for the price to approach the support level.
  • Confirm that the RSI is below 30, indicating oversold conditions.
  • Enter a buy order when the price touches the support level, and the RSI confirms oversold status.

• Selling at Resistance:
  • Monitor the price as it nears the resistance level.
  • Confirm that the RSI is above 70, indicating overbought conditions.
  • Enter a sell order when the price touches the resistance level, and the RSI confirms overbought status.

Set Stop-Loss and Take-Profit Levels

• For buy orders, place a stop-loss slightly below the support level.
• For sell orders, place a stop-loss slightly above the resistance level.

Take-Profit:

• Set take-profit orders near the opposite level of the range (e.g., set take-profit near the resistance level for buy orders).

Monitor and Adjust

• Keep an eye on market news that could cause breakouts.
• Adjust your positions if support and resistance levels shift.

Example:

• Asset: EUR/USD currency pair
• Time Frame: 1-hour chart
• Range: Support at 1.0800, resistance at 1.0900
• Action: Price drops to 1.0800, and RSI reads 25
  • Enter a buy order at 1.0800
  • Set stop-loss at 1.0780
  • Set take-profit at 1.0900

Advanced Range Trading Strategy for Seasoned Traders

Objective: Enhance the basic range trading strategy by incorporating multiple technical indicators and risk management techniques to improve signal accuracy and profitability.

Identify the Range with Precision

• Use Bollinger Bands to visualise volatility and confirm range boundaries.
  • The upper band can act as a dynamic resistance level.
  • The lower band can act as a dynamic support level.

Incorporate Multiple Confirming Indicators

• Stochastic Oscillator
  • Measures momentum and can indicate overbought (above 80) and oversold (below 20) conditions.

• Volume Analysis
  • Use On-Balance Volume (OBV) to assess buying and selling pressure.
  • Increasing volume near support may indicate a stronger bounce.

Set Entry and Exit Points with Confluence

• Buying at Support:
  • Price approaches lower Bollinger Band and static support level.
  • RSI is below 30, and the Stochastic Oscillator is below 20.
  • OBV shows increasing volume.
  • Enter a buy order when all conditions align.

• Selling at Resistance:
  • Price nears upper Bollinger Band and static resistance level.
  • RSI is above 70, and the Stochastic Oscillator is above 80.
  • OBV indicates decreasing volume (divergence).
  • Enter a sell order when these conditions are met.

Advanced Risk Management

• Position Sizing:
  • Use the Percent Risk Model to determine position size based on a fixed percentage of your capital (e.g., risk 1-2% per trade).
• Trailing Stop-Loss:
  • Instead of a fixed stop-loss, use a trailing stop to lock in profits as the trade moves in your favour.
• Multiple Take-Profit Levels:
  • Scale out of positions by setting multiple take-profit levels (e.g., exit half the position at the midpoint of the range and the rest at the resistance level).

Monitor for Breakouts

• Be vigilant for signs of a breakout from the range, which can be identified by:
  • Price closing beyond the Bollinger Bands with high volume.
  • RSI and Stochastic moving out of overbought/oversold zones without a price reversal.

• Strategy Adjustment:
  • If a breakout is detected, consider reversing your position or standing aside.

Backtesting and Optimisation

• Use historical data to backtest your strategy.
• Optimise parameters like indicator periods and stop-loss distances based on backtesting results.

Example:

• Asset: S&P 500 Index
• Time Frame: 4-hour chart
• Range: Support at 4,800, resistance at 5,000
• Indicators Used:
  • Bollinger Bands (20-period moving average, 2 standard deviations)
  • RSI (14 periods)
  • Stochastic Oscillator (14, 3, 3)
  • OBV for volume analysis
• Action:
  • Price touches support at 4,800 and lower Bollinger Band
  • RSI is at 28, Stochastic is at 15
  • OBV shows increasing volume
  • Enter a buy order at 4,805
  • Set a trailing stop-loss starting at 4,780
  • Take-profit levels at 4,900 (mid-range) and 5,000 (resistance)

Additional Tips for Both Strategies

• Market Conditions – Ensure the market is indeed ranging and not transitioning into a trend. Avoid range trading during major economic announcements.
• Emotional Discipline – Stick to your strategy and avoid impulsive decisions. Use alerts and automated orders if necessary.
• Continuous Learning – Keep updating your knowledge about technical indicators and market behaviour.

Conclusion

Building a trading strategy around support and resistance levels in ranging markets can be effective when combined with appropriate confirming indicators. Beginners should start with simple strategies using one or two indicators like RSI, while seasoned traders can enhance their approach by incorporating multiple indicators, advanced risk management techniques, and continuous optimisation through backtesting.

Remember, no strategy guarantees success, and it’s crucial to manage risk effectively. Always practice on a demo account before applying strategies with real capital.

Using Support and Resistance After a Breakout

Understanding Breakouts

• A breakout occurs when the price moves above a resistance level or below a support level.
• This signals a potential new trend in the market, either upward or downward.

Should You Use Support and Resistance After a Breakout?

Yes, but understand that their roles may change:

• Old Resistance Becomes New Support – If the price breaks above resistance, that resistance level may now act as support.
• Old Support Becomes New Resistance – If the price breaks below support, that support level may now act as resistance.

Simple Example

• Scenario: A stock has been ranging between $90 (support) and $100 (resistance).
• Breakout: The price breaks above $100 and closes at $102 with high volume.
• Action Plan:
  • Entry: Buy the stock at $102 after confirming the breakout.
  • Stop-Loss: Set at $99 to limit potential losses.
  • Take-Profit: Aim for $110, anticipating the price may move up by the size of the previous range ($100 – $90 = $10).

Key Points to Remember

• Adapt Your Strategy – Shift from range trading to trend following after a breakout.
• Use Simple Indicators – Tools like moving averages and RSI can help confirm trends.
• Risk Management – Always use stop-loss orders and only risk a small portion of your trading capital.
• Stay Informed – Keep an eye on market news that could impact price movements.
• Practice Makes Perfect – Consider using a demo account to practice this strategy before using real money.

Conclusion

After a breakout, support, and resistance levels remain useful but serve different purposes. By adjusting your strategy to the new market conditions and using basic technical indicators, you can effectively capitalise on new price trends without getting overwhelmed by complex technical details.

How do Support and Resistance Affect the Markets?

Here are a few real-life case studies showing how strong Support and Resistance levels can affect market sentiment and asset prices.

Apple’s Resistance Breakout in 2012

In 2012, Apple Inc.’s stock price faced strong resistance around the $100 mark (adjusted for stock splits). After several attempts, the stock decisively broke through this resistance level in September 2012.

As a result, the breakout above the $100 resistance was interpreted as a bullish signal. Investors anticipated continued growth due to new product launches like the iPhone 5.

Following the breakout, Apple’s stock price experienced significant appreciation, reinforcing the importance of resistance levels in stock valuation.

Source:

• Apple Inc. SEC Filings: SEC Edgar
• Historical Stock Data: Nasdaq

Gold Prices and the $1,900 Resistance Level

Gold prices reached a historic high near $1,900 per ounce in 2011 but failed to sustain above this level, establishing it as a strong resistance point. It wasn’t until August 2020 that gold broke through this resistance amid global economic uncertainty.

Surpassing the $1,900 resistance level signalled a strong bullish trend for gold. Investors flocked to gold as a safe-haven asset during the pandemic-induced economic downturn.

The breakout led to gold reaching new all-time highs above $2,000 per ounce, underscoring how overcoming resistance levels can lead to significant price movements.

Source:

• World Gold Council Reports: Gold Demand Trends
• Gold Price Historical Data: Kitco

The 2020 COVID-19 Market Crash and Support Levels

In March 2020, global markets plummeted due to the onset of the COVID-19 pandemic. The Dow Jones Industrial Average found support around the 18,000 level, a significant support point last seen in 2016, and it held.

The bounce from the 18,000 support level signalled to traders that the market might be reaching a bottom. This support level held, and coupled with fiscal stimulus measures, it led to renewed buying. The market began a robust recovery in the following months, demonstrating how critical support levels can influence investor confidence during crises.

Source:

• Bloomberg News Articles (March-April 2020): Bloomberg
• Dow Jones Historical Data: MarketWatch

These examples illustrate the critical role that support and resistance levels play in financial markets. They act as psychological barriers and decision points for traders and investors, often influencing market trends and momentum.

For more detailed analyses, you might refer to:

• Edwards, R. D., Magee, J., & Bassetti, W. C. (2018). Technical Analysis of Stock Trends. CRC Press.
• Pring, M. J. (2002). Technical Analysis Explained. McGraw-Hill Education.

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Support & Resistance main FAQs

• Which time frame is best for support and resistance levels?

  There’s no ‘best’ time frame for finding support and resistance levels. Traders can use whichever time frame works best with their trading style and strategies. The same trader might use a four-hour chart for one strategy and a weekly chart for another strategy. In general a long-term trader will use daily to monthly charts, a swing traders could use anything from a 4-hour chart to a weekly chart, a day traders would use time frames from 15-minutes to daily charts, and a scalper would use charts from four-hours down to tick charts that plot every tick in the market.
• What are the best tools and indicators for support and resistance trading?

  Again, there are no ‘best’ tools, but there are tools that each trader will favour in their own trading strategies. Fibonacci levels are one very popular set of indicators used widely in determining support and resistance. Many traders also make heavy use of moving averages when determining support and resistance level, and pivot points are also quite popular. Also used heavily for determining support and resistance levels are the price bands such as Keltner Channels, as well as other types of trend lines and channels.
• How important are round numbers as support and resistance?

  One of the more interesting and noted aspects of support and resistance is the inability of price to move through round numbers such as $20 or $50. Of particular importance are the large round numbers such as $100 or $1,000. This phenomenon occurs because many inexperienced traders tend to buy when prices are at whole levels because they seem to think assets are most fairly valued when they reach these levels. Also, most stop and limit orders placed are at round numbers. It’s more likely to see a stop or limit order at $100 than at $100.06. With so many orders being placed at the same level, these levels come to act as strong price barriers.

** Disclaimer – While due research has been undertaken to compile the above content, it remains an informational and educational piece only. None of the content provided constitutes any form of investment advice.