Support and resistance levels are significant levels on the asset chart that the price has a chance of retracing from. Trading on breakouts and trend reversals is a popular method of choosing market entries.
Support and resistance lines are the most obvious technical analysis indicator. At the very least, you should give them a chance because a lot of investors and traders all over the world rely on the use of them.
Support and resistance lines on the chart
The horizontal line in the IQ Option drawing panel
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. Support and resistance levels can help traders figure out at what point to purchase an asset with a falling price, and when to consider selling it.
As you can see, support and resistance levels reflect 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.
When the price approaches levels that it bounced back from in the past, it can rebound again, thus forming a price channel.
The picture above 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. Some traders treat the rebound as an entry opportunity, closing the deal when the price gets to the upper boundary.
Similarly, an entry point for selling is the moment of rebound from the level of resistance at the upper edge, exiting the deal at the support level. In addition to the horizontal levels of support and resistance, there are also inclined levels. These are called trend lines.
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.
Note that you can also add horizontal levels on the price chart as a part of the general strategy.
Potential entry points on horizontal levels
It is also possible for an old resistance level to turn into a new support line (when the asset price goes up), and vice versa for a downward price movement. Arrows point to potential entry points, that could have been used in this particular case. Retracements in the direction of the trend can be treated as one of the signals.
If the retracement is stronger and the price breaks through the trend support, traders consider applying a strategy based on breaking out of the support and resistance levels.
Support and resistance breakouts sometimes offer an opportunity to ride a strong trend. Note that this technique is harder to use than the previous one, because the trader needs to watch the market almost constantly so as not to miss an entry point. 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.
Entering the market after a breakout retracement
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.
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, some traders prefer to enter with the retracement after the breakout.
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 need to learn how to build support and resistance lines and monitor the background news to avoid running into an unexpected breakout. Remember that no technical analysis instrument is 100% accurate, as all of them can provide false signals.