Identifying patterns is one of the most common strategies in Day Trading. Using Support and Resistance will give you many advantages
Another common strategy used by traders is price action, which involves looking at charts and identifying patterns. A common feature in technical analysis and price action is the use of support and resistance.
In this article, we will look at what this method is and how you can use it in the market.
What is Support and Resistance?
Traders in the financial market observe patterns to predict what will happen in future. There are many patterns that they observe. For example, there are candlestick patterns like evening and morning star and Doji that they use to predict what will happen.
Support and resistance are levels where a financial asset find it difficult to pass.
A support is a level at which demand is said to be so strong such that it prevents a price from going below. It can be viewed as a floor where a currency or a financial asset struggles to pass below.
The logic behind this is simple: When a price of an asset is declining, it means that buyers become more inclined to buy and sellers more inclined to sell. When the price reaches the support level, it is thought that demand will overcome supply.
A resistance level is the opposite of a support. This is where selling is said to be very strong to prevent the price from moving higher. As the price climbs towards the resistance, it is thought that sellers become more inclined to sell and buyers become less inclined to buy.
A resistance level is thought to be a ceiling. The chart below shows a good example of a support (red) and supply (blue) on the USD/JPY pair.
How to Draw S&R Levels
There are several approaches of drawing support and resistance levels. The most basic approach is the one showed above. You simply draw a line that connects high and low levels. These levels can be drawn horizontally (as shown above) or diagonally.
Another approach is to look at psychological levels. These are levels that have a significance importance to traders. For example, traders love levels that have round numbers. On the chart below, support and resistance levels appear on 108 and 114 respectively.
How to Trade With Support and Resistance
There are several methods of using S&R. The best way is to trade using a channel. A good example is shown on the previous charts. The idea is to buy when the asset hits the support level and short when it hits the resistance level. This method works very well.
→ Our Post about Short Selling Stocks
However, you need to be careful of a breakout. A breakout happens when the price moves past the support and resistance and starts moving higher. When it happens on a support, it means that bears have prevailed. This does not mean that the price will continue moving in the direction of the breakout.
In some cases, it may reverse, in what is known as a false breakout. The chart below shows when a breakout happens.
Another strategy is to use support and resistance levels as a way of putting a stop loss and a take profit. A stop loss is a location where you want to take the maximum loss.
In most cases, these levels usually happen at areas of support and resistance.
External Useful resoursces
How to Identify Support and Resistance Levels on a Stock Chart – SwingTradeStocks
Stop Trading S&R The Wrong Way – Mark Soberman on Medium