In the today's article, we will discuss the absolute basics of technical analysis: support and resistance levels.
I will explain to you:
what is support and resistance in trading,
why support and resistance are important,
how to identify them properly,
what is the difference between support and resistance level and support or resistance zone.
What is Support and Resistance
Let's start with a definition of a support.
A support is a historically significant price level that lies below the current prices of an asset.
While a resistance is a historically significant price level that is above the current prices.
From a key resistance, a bearish movement will be anticipated in the future, while from a key support, a bullish reaction will be expected.
Take a look at EURAUD pair, we can see a perfect example of a key resistance level.
2 times in a row, the market dropped from that in the past, confirming its significance.
By a historical significance, I mean that the price reacted strongly to such price level in the past and a strong bullish, bearish movement initiated from that.
Above is the example of a key horizontal support on EURCHF. The underlined key level was respected by the market multiple times in the past.
Support and Resistance Breakouts
From time to time, the market breaks key levels.
After a breakout, a support turns into resistance
and a resistance turns into support.
Above is the example of a breakout of a key support on GBPNZD, after its violation it turned into resistance from where a bearish movement followed.
Always remember, that in order to confirm a breakout of a key support, we strictly need a candle close below that.
By the way, the structure above is also the zone, but we will discuss it later on.
Above is the example of a breakout of a key resistance on USDCHF, that turned into support after a violation.
Valid Support and Resistance
Very often, newbie traders ask me, how many times the price should react to a key level to make it valid.
I do believe that 1 time is more than enough, however, make sure that the reaction to that is strong.
Above are key support and resistance on GBPCAD. Even though both structures were respected just one time in the past, the reaction to them was strong enough to confirm that the underlined levels are the key levels.
Invalid Support and Resistance
However, historical significance of a key support or resistance is not enough to make it valid.
What matters is the most recent reaction of the price to that.
Key supports and resistance lose their significance with time, and your job, as a technical analyst, is to stay flexible and adapt to changing market conditions, regularly updating your analysis.
Above is a key resistance level on AUDJPY from where the market dropped heavily 2 times in a row.
However, with time, the underlined resistance lost its significance.
Such a structure is not a key level anymore.
Remember a simple rule: if a key structure is not respected by the sellers, and by the buyers after its breakout.
Or vice versa: if a key structure is not respected by the buyers, and then by the sellers after its breakout.
Such a structure is not a key level anymore, and you should not rely on that in the future.
In our example, the resistance was broken - it was neglected by the sellers. After the breakout, it should have turned into support, but the buyers also neglected that and the structure lost its strength.
Support and Resistance Time Frames
Now, a couple of words about time frames.
You can identify key support and resistances on any time frame, but
the rule is that higher is the time frame, more significant are the supports and resistances there.
In my analysis, I primarily rely on support and resistance on a daily time frame.
Support and Resistance Zones
Always remember that the financial markets are not perfect, and the prices will quite rarely respect the exact support or resistance levels.
Quite often, the markets may fluctuate around key levels, so it is highly recommendable to rely not on single key levels but on zones.
I recommend taking into consideration not only the exact level from where a strong reaction followed, but also a candle close level of such a candle.
The support zone above is based on a wick and a candle close of a candle.
Also, quite often there will be the situations when multiple key levels will lie close to each other.
In such a case, it is better to unite all this structures in one single zone.
Above we see multiple key resistances.
We will unite all these resistances into one single zone. The upper boundary of a resistance zone will be the highest wick and its lower boundary will be the highest candle close.
Above we have 2 key supports lying close to each other.
We will unite these supports into one single zone.
The lower boundary of a support zone will be the lowest wick and the upper boundary will be the lowest candle close.
Complete Structure Analysis
And here is how a complete structure analysis should look.
Following the rules that we discussed, you should identify at least 2 closest key resistances and 2 closest key supports.
These structures will be applied as the entries for various trading strategies.
