What is Support and Resistance?
Support and resistance levels are an extremely important concept in technical trading. A large number of market participants continuously follow and monitor major support and resistance levels to identify trade setups and price-levels which could potentially invalidate that setup, i.e. stop-loss levels. In this article, we’ll take a close look at what support and resistance levels are, how they form and how to trade them.
What is a Support Level?
A support level is a price-level at which the followed financial instrument could face increased buying pressure, i.e. demand. Support levels are usually previous swing lows in the price, but can also be price-levels located on technical tools such as a trendline, channel or Fibonacci levels.
Simply put, support levels are price-levels at which the price had difficulties to move below in a previous attempt. Technical traders and other market participants will therefore likely look at these price-levels as zones at which increased demand for the instrument could form again. A simple horizontal support level is shown on the following chart, marked by the red line.
The price repeatedly failed to break below the 1.0854 level, which could, therefore, be identified as a support level on the 1-hour EUR/USD chart. A trader could look to place a stop-loss order just below the support level in case of a long position.
What is a Resistance Level?
Resistance levels are similar to support levels, with the only difference that they signal a price level at which an asset could face increased selling pressure, i.e. supply. Resistance levels form at previous swing highs, but can also form at other technical tools just like in the case of support levels.
Resistance levels are price-levels at which the price had difficulties to break above in previous attempts, and which could, therefore, host a large number of sell orders that, when executed, could send the price lower. The following chart shows a simple horizontal resistance level.
As you can see, the 1.1224 price-level on the 1-hour EUR/USD chart has acted as a barrier for the price in multiple previous attempts to break above. Technical traders usually place their stop-loss order just above the resistance level, in case of a short position.
Types of Support and Resistance
Besides horizontal support and resistance levels, there are a few additional types which any trader should know about. We’ll discuss them briefly in the following lines.
1) Round numbers – According to human psychology, round-number price-levels often act as support and resistance levels, as they can host a large number of pending buy and sell orders placed by market participants. Examples of the importance of round numbers can be found in various financial markets. The 1.20, 1.25 or 1.30 exchange rates could act as important levels in the GBP/USD pair. In the stock market, if the price of a stock reaches towards the $10, $50, $100 or any other round number, bear in mind that these prices could act as support and resistance levels for the stock.
2) Trendline S&R – Support and resistance levels can also form at trendlines and channels. The following chart shows the 15-minutes EUR/USD chart with support levels marked by green circles. Each time the price tests the trendline, increased buying pressure can cause the price to bounce off those levels.
3) Fibonacci S&R – The Fibonacci tool is often used to identify price reversals during market corrections. In other words, Fibonacci levels could act as support and resistance for the price, as shown on the following chart.
4) Indicator S&R – Technical indicators can also be used to spot support and resistance levels in the market, such as the 200-day moving average which acts as an important S&R line, or pivot points which are used as pivot support and resistance levels.
Support and Resistance Levels Can Switch Their Roles
An important phenomenon that occurs in the market over and over again is the changing of roles between support and resistance levels. When the price drops below a support level, there is a high chance that the same level will act as resistance in the future. Similarly, when a resistance level breaks on a short timeframe, short-term traders should mark that level as a potential support level in the future.
This is the reason why traders look for pullbacks to enter the market. A pullback is simply a return of the price to the previously broken support or resistance level, only to continue in the breakout direction again. This principle is shown on the following chart and can be used to create a complete trading strategy around it.
Support and resistance levels act as barriers for the price to move below or above those price-levels, respectively. Traders can profit from trading support and resistance levels in a variety of ways: by trading horizontal S&R levels, trendline and channel S&R levels, Fibonacci retracements, round-number S&R levels and technical indicators. Nevertheless, always look for additional confirmations (from candlestick patterns, for example) before entering into a trade based on S&R levels.