SUPPORT AND
RESISTANCE
Support and resistance is one of the most widely used concepts in trading.
Strangely enough, everyone seems to have their own idea on how you should
measure support and resistance.
Let’s just take a look at the basics first.
As you can see in the diagram above, this zigzag pattern is making its way
up (bull market). When the market moves up and then pulls back, the highest
point reached before it pulled back is now resistance.
As the market continues up again, the lowest point reached before it started
back is now support. In this way resistance and support are continually
formed as the market oscillates over time. The reverse of course is true of
the downtrend.
Plotting Support and Resistance
One thing to remember is that support and resistance levels are not exact
numbers. Often times you will see a support or resistance level that appears
broken, but soon after find out that the market was just testing it. With
candlestick charts, these "tests" of support and resistance are usually
represented by the candlestick shadows.
Notice how the shadows of the candles tested the 2500 resistance level. At
those times it seemed like the market was "breaking" resistance. However, in
hindsight we can see that the market was merely testing that level.
So how do we truly know if support or resistance is broken?
There is no definite answer to this question. Some argue that a support or
resistance level is broken if the market can actually close past that level.
However, you will find that this is not always the case. Let's take our same
example from above and see what happened when the price actually closed past
the 2500 resistance level.
In this case, the price had closed twice above the 2500 resistance level but
both times ended up falling back down below it. If you had believed that
these were real breakouts and bought this pair, you would've been seriously
hurt! Looking at the chart now, you can visually see and come to the
conclusion that the resistance was not actually broken; and that it is still
very much in tact and now even stronger.
So to help you filter out these false breakouts, you should think of support
and resistance more of as "zones" rather than concrete numbers. One way to
help you find these zones is to plot support and resistance on a
line
chart rather than a
candlestick chart. The reason is that line charts only show you
the closing price while candlesticks add the extreme highs and lows to the
picture. These highs and lows can be misleading because often times they are
just the "knee-jerk" reactions of the market. It's like when someone is
doing something really strange, but when asked about it, they simply reply,
"Sorry, it's just a reflex."
When plotting support and resistance, you don't want the reflexes of the
market. You only want to plot its intentional movements.
Looking at the line chart, you want to plot your support and resistance
lines around areas where you can see the price forming several peaks or
valleys.
Other interesting facts about support and resistance:
1.
When the market passes through resistance, that resistance now becomes
support.
2.
The more often price tests a level of resistance or support without
breaking it the stronger the area of resistance or support is.
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