Support and resistance levels are fundamental concepts in technical analysis.
They play a vital role in understanding market dynamics, and making good trading decisions.
These levels serve as key reference points on trading price charts, and provide valuable insights into potential price movement.
In this post we take a close look at support and resistance levels in trading, how to plot them, and use them to increase your trading success.
What are support and resistance levels in trading?
Support and resistance levels are not just lines on a chart. They represent the collective psychology of all market participants, and the eternal battle between the bulls and the bears.
Support levels reflect the willingness of buyers to step in and buy at a particular low price.
Resistance levels indicate a reluctance to let the price rise beyond a certain point.
They are fundamental principles that apply to all trading charts showing price action.
Such levels can be identified no matter what type of asset you trade, or the timeframe you use.
Understanding the role that support and resistance plays is vital for beginner traders.
These levels influence a range of other aspects of your trading, such as:
- How you determine your potential risk for any one trade
- The best price to place your stop loss order at
- Where to take profit at the top or bottom of a trend
Because they are so important, it is vital for new traders to know:
- What is support and resistance in trading?
- How to find support and resistance levels
- The best way to draw support and resistance lines
- How to use identified support and resistance levels in your trading strategy
Support
Support refers to a price level where the demand for an asset is strong enough to prevent further decline.
A support level represents a low price at which a financial asset tends to stop falling in value, and bounces back up.
It is a level at which the price of the asset is supported by buyers, and so doesn’t tend to fall below that level.
It acts as a floor or a barrier, where buying interest typically increases, leading to a bounce up or reversal in price.
Support and resistance trading involves viewing support levels as an opportunity to buy or enter long positions, anticipating a price rebound.
Resistance
A resistance level is the opposite of support – it’s a price point where selling pressure outweighs buying pressure, preventing the asset’s price from rising any further.
It acts as a ceiling or a price cap, where selling interest typically intensifies, causing the price to stall or reverse direction.
Traders often view resistance levels as opportunities to sell or enter short positions, expecting a price pullback.
Support and resistance indicators
Support and resistance price levels are based on past price action, and represent price points where significant buying or selling activity has occurred in the past.
As a result, these indicators tend to attract attention from traders, and so can act as self-fulfilling prophecies, influencing future price movements.
Some traders base their entire trading strategy on support and resistance levels, using past price action as an indicator of future price behaviour.
- They aim to buy at the lower end of the price range, in the support ‘zone’ for a long trade (or reverse for a short trade)
- They sell when the price moves close to a known resistance (or support) level
- Other traders use breakouts from known support or resistance levels as trade entry signals
Think of these two values like the roof and ceiling of a house.
Price action may bounce around in the room, but it is restrained from falling below the floor (support) or from flying above the ceiling (resistance.)
Typically, price action respects support and resistance levels, and the price may bounce up and down between support and resistance levels many times within that particular trend.
However, no support or resistance levels last forever, and when price action suddenly does move above or below these key important levels, a ‘breakout’ occurs.
What is a price breakout?
A breakout means that price action suddenly breaches support or resistance.
Traders take note when a breakout occurs, because it usually signals the end of one particular trend, and the start of another.
In my experience of trading, if price action has been respecting a particular support or resistance level for a long period of time, when it does break out, the price movement tends to be sudden and spectacular.
It is like the asset has been gaining energy or momentum all the time it is bouncing between support and resistance lines.
Once that floor or ceiling has been breached, the bouncing ball is suddenly free, and it releases all its pent-up energy to shoot higher or lower.
Price action respecting support and resistance lines (the black lines) then suddenly breaking out once the top resistance line has been breached
How to find support and resistance levels
Several methods are used to identify support and resistance levels:
- Historical price data analysis: Traders analyse historical price data to identify recurring patterns where the price has previously bounced off or struggled to surpass certain levels. These historical levels become significant support or resistance ‘zones.’
In this example showing daily price action over several months, it’s easy to see how price action has bounced around within a support and resistance ‘zone’ for many days before finally making a dramatic downward breakout.
- Moving averages: Moving averages, such as the simple moving average (SMA) or exponential moving average (EMA), can be utilised to identify dynamic support and resistance levels.
In this example, the 20-day simple moving average (SMA) line (the blue line) could be used as a trailing stop loss indicator if you were trading this uptrend.
- Chart patterns: Certain candlestick chart patterns, such as double tops, double bottoms, and head and shoulders patterns, can also indicate potential support and resistance levels. These patterns are formed by the collective behaviour of market participants and are closely monitored by traders.
In the example below, the double top pattern clearly shows where there is a resistance to price action moving above this level (marked by the black line.)
How to draw support and resistance lines
Here are some guidelines for drawing support and resistance lines:
Identify significant price levels
Start by identifying significant price levels where the price has previously experienced reversals or consolidation.
These levels can be determined by analysing historical price data and identifying points where the price has repeatedly bounced off or struggled to move above a particular price point.
Look for significant swing highs and lows on the price chart.
A swing high occurs when the price reaches a peak and then reverses, while a swing low occurs when the price reaches a trough and then reverses.
These points represent areas where buying or selling pressure has temporarily exhausted, indicating potential support or resistance levels.
Connect multiple touch points
Use horizontal lines to connect multiple swing highs or lows that are close to each other.
When drawing support and resistance lines, aim to connect multiple points where the price has reacted to the same or a similar level.
The more touch points a line has, the more significant it is considered to be. This helps validate the importance of the support or resistance level.
In this example, there are two touches of price action on each of the upper and lower channel support and resistance lines.
A strong support or resistance line has to have at least three touch points with the top or bottom of candlesticks.
Use both horizontal and diagonal lines
While horizontal lines are commonly used to represent support and resistance levels, diagonal trendlines can also be employed to identify dynamic support and resistance areas.
Diagonal trendlines are also drawn by connecting consecutive swing highs or swing lows, as in the example above.
As I taught beginner traders, I found they got better at identifying support and resistance lines with practice.
It’s worth spending time practicing drawing support and resistance lines, as they are universally used for all kinds of trading.
Be aware of round number bias
Round numbers or key price levels ending in zeros or fives are often significant. They frequently mark the support or resistance level.
This phenomenon is known as round number bias.
This phenomenon occurs when individuals exhibit a tendency to place greater significance or attention on numbers that end in 0 or 5 due to their perceived simplicity or completeness.
Traders often pay close attention to these levels, and they tend to attract buying or selling interest.
In my experience, round number bias has a strong influence on support and resistance points, so it’s worth treating this psychological phenomenon seriously.
Consider the timeframe
Support and resistance levels can vary across different timeframes. Therefore, it’s essential to consider the timeframe you are trading on when drawing support and resistance lines.
Higher timeframes tend to have stronger and more reliable support and resistance levels.
The example below is from a weekly chart of EUR/USD. It clearly shows price action respecting support and resistance levels over a period of many months.
Focus on recent price action
Pay close attention to recent price action when identifying support and resistance levels.
Levels that have been established more recently may carry more significance than those from historical data, especially in rapidly changing market conditions.
When support and resistance meet up
Once an upward price breakout occurs, the former ‘ceiling’ for price action often then becomes the new support level.
Price action may initially rise quickly, but often then retreats, respecting it’s former resistance level or ‘ceiling’ as a new floor support level.
The same applies in reverse. If price action breaks down below a previous support level, that price point will often become the new resistance ceiling.
Why are support and resistance levels useful?
Traders use support and resistance levels to identify potential entry and exit points.
They are also important because they often form part of a risk management strategy.
For example, if a trader is in a long trade, and price action breaks below a known support level, then that may signify a downward breakout, and so trigger an exit from the trade to minimise loss.
These important levels also help traders to formulate their trading strategies.
Buying near support and selling near resistance allows traders to capitalise on price reversals, maximising profit potential while minimising downside risk.
How to use support and resistance levels to improve trading success
Support and resistance levels play a pivotal role in formulating effective trading strategies for these reasons:
- Entry and exit points:
We use support and resistance levels to determine optimal entry and exit points for our trades.
Buying near support levels and selling near resistance levels can enhance the probability of successful trades.
- Risk Management:
Support and resistance levels act as a guide as to where to set stop-loss orders to mitigate potential losses.
Placing stop-loss orders below support levels or above resistance levels helps us manage risk effectively.
- Trend Confirmation:
Breakouts above resistance levels or breakdowns below support levels can signal potential trend reversals or continuations.
However, you should always wait for confirmation through price action before entering trades based on breakouts or breakdowns, as they can often fail.
Final thought about support and resistance levels in trading
Identifying key support and resistance levels, and incorporating them into your trading strategy, can help you improve your trading performance.
They can be a reliable indicator of important psychological price barriers. Once a key support level has been breached, a breakdown to a lower price level often follows.
Similarly, if a key resistance level is breached, a dramatic upward breakout very often results.
It’s as if a pressure point has been released, and once that pressure is off, then the sky is the limit!
Therefore, whatever trading strategy you use, whether it is based on support and resistance levels or not, it’s always a good idea to be aware of where they are.
Pay attention to them, and keep them in the back of your mind at all times when you’re deciding on stop-loss and take-profit levels.
However, always remember that support and resistance levels are not static. They change and evolve over time as market dynamics change.
Here you can find out more about drawing support and resistance and trend lines, and trend trading strategies.
Till next time, I wish you safe and happy trading.
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Sources
Marketmates uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial guidelines to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
- Munehisa Homma – Candlestick Charts https://en.wikipedia.org/wiki/Candlestick_pattern
- Louise Bedford – The Secret of Candlestick Charting https://www.tradinggame.com.au/product/technical-analysis/the-secret-of-candlestick-charting
- Charting software – TradingView.com TradingView.com
