Support and resistance levels are significant levels on the asset chart that the price often retraces from, and trading on breakouts and trend reversals is one of the most popular methods for choosing market entries.
Support and resistance lines are the most obvious technical analysis indicator. At the very least, you should be using them because investors and traders all over the world rely on them.
Support and resistance lines on the chart
You can draw these lines on any kind of chart: bar, candlestick, area, or line. But as with other forms of technical analysis, they are best visible on candlestick and bar charts (clickable images):
Support and resistance levels help traders to figure out at what point to purchase an asset with a falling price, and when to count on the price increasing.
As you can see, support and resistance levels reflect the peaks and troughs on the price chart. These local price extremes are the foundation of trading. They reflect the law of the financial market – seller supply and buyer demand. Support and resistance levels are formed on the chart because bidders are guided by the price level that the price reached the last time. They do not want to take risks, and begin to get rid of their current positions at a safe level.
Traders who use support and resistance levels have strategies in their arsenal both for rebounds from the level and breakouts of the level.
Rebounds
When the price approaches levels that it bounced back from in the past, it is highly likely to rebound again, thus forming a price channel.
Trading support and resistance shows the price movement in a flat with clear boundaries. The upper limit of the flat serves as resistance for the market, and the lower limit – as support. The first effective entry point to the market for buying is the moment of rebound from the support level, taking profit at the opposite boundary.
Similarly, an entry point for selling is the moment of rebound from the level of resistance at the upper edge, taking profit at the support level. In addition to the horizontal levels of support and resistance, there are also inclined levels. These are called trend lines
Triangle support and trend
The trend line and the level of support form a triangle
Trend lines indicate the direction of price movement. They are built using the local maximums of the downtrend and minimums of the uptrend.
Trend trading is considered effective with a strategy that uses horizontal levels
Horizontal lines and support levels
Entry points on horizontal levels
Price resistance levels after a breakout may well serve to support the price in the future. The arrows point to entry points for buying. The entry is made on price retracements in the direction of the trend.
If the retracement is stronger and the price breaks through the trend support, traders apply a strategy based on breaking out of the support and resistance levels.
Breakouts
Breakouts of the support and resistance levels are an excellent opportunity for a trader to catch a strong price momentum. This approach is more difficult to use than the first one, because the trader needs to watch the market almost constantly so as not to miss the point of entry. Many traders who take advantage of the breakout don’t enter immediately, but wait for the retracement after the breakout, and only then make their entry.
Support comes resistance line
Entering the market after a breakout retracement
Fakeout
Breakouts of the support and resistance levels can be real or fake. False breakouts often mislead traders, since the price broke through the level and should be on a good wave, but it turns out exactly the opposite – the price goes back behind the level and heads in the opposite direction.
False support level breakout
In such cases it is best to wait until the close of the next candlestick after the break and analyze the market situation. If the price comes back after the breakout and the candlestick is drawn opposite to the breakout, then this is probably a fakeout.
In the event of a true breakout of the trend, it’s best to enter with the retracement after the breakout.
Conclusion
Trading on support and resistance levels takes advantage of the psychology of the masses – market participants focus on how the price behaved in a similar situation in the past. They measure the maximum and minimum prices over the current time interval (for example, over the past week), and evaluate events that took place during this time or that might occur in the near future. If the background information related to the asset doesn’t suggest any disturbances and there aren’t any events that would affect the asset more than in the past week, it is logical to assume that the price will remain in the same corridor going forward.
To trade using this method, you only need to learn how to build support and resistance lines and monitor the background news to avoid running into an unexpected breakout.