At the most basic level, support and resistance are simple concepts. To determine them, the maximum and minimum price indicators are displayed, acting as a kind of barrier. At the same time, the lower values of the chart represent the support level , and the upper values represent the resistance level . In fact, the level of support can be viewed from the point of view of demand, and the level of resistance – from the point of view of supply.
Despite the fact that support and resistance levels are usually denoted by lines, in reality they usually look different. It should be borne in mind that markets are not governed by any physical law that does not allow indicators to go beyond a certain level. Therefore, it is more appropriate to consider support and resistance levels as areas. You can imagine these areas as ranges on the price chart, the approach to which is likely to cause increased activity of traders.
How Traders Use Support and Resistance levels
Technical analysts use support and resistance levels to identify areas of interest on the price chart. At these levels, the main trend is likely to change its direction.
Market psychology plays an important role in the formation of support and resistance levels. Traders and investors are guided by price levels that previously caused increased interest and trading activity. These areas will contribute to increased liquidity as many traders will be tracking the same price levels. Often, support and resistance zones create ideal conditions for entry or exit from a position for large traders.
The concepts of support and resistance levels are key to effective risk management. Your trading opportunities may depend on your ability to consistently identify these zones. Usually, after the price reaches the support or resistance area , two possible events are possible. It either bounces off this area, or breaks through it and continues moving in the direction of the trend to the next potential support or resistance area .
It is best to enter a trade when the price is near the support or resistance level , mainly because of its relative proximity to the cancellation point, where a stop loss order is usually placed. In case of a breakthrough of the area and invalidation of the transaction, traders will be able to reduce their losses, because the further the entry is from the supply or demand zone , the further the point of invalidation of the transaction.
At the same time, you need to understand how these levels will change depending on changes in the situation on the chart. As a rule, a breakdown in the support area can turn it into a resistance area . Conversely, a broken resistance area may turn into a support area when it is retested. This pattern is called the support-resistance flip.
How to draw support levels correctly?
- Reduce the timeframe of your charts so that you can see the bigger picture.
- Draw the most obvious levels that tend to have the strongest price bounces.
- Adjust your levels to get the maximum number of touches.
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