To be successful in the markets, you should know how to read the charts by identifying support and resistance levels. It is essential for a trader not to listen to random gossip on the finance TV or random youtube videos to make an informed decision while trading. It would help if you had a well-planned strategy to succeed in the global market while trading. And this well-planned strategy includes a thorough understanding of the charts and graphs.
Support and resistance levels are two major metrics that you can see on the chart to know the perfect time to enter or exit the trade. The overview of the support and resistance levels is that around these two levels, the previous price has the potential to change in opposite trends direction. Thus, they give you a clear insight into the price trends.
What are support and resistance levels?
Support and resistance levels are two areas on a chart where price trends may change their direction and restrict the range of movement. The support level is the point that supports the price to decrease further. At this level, the buying power or demand is extreme. The resistance level is the point that resists the price to increase further. At this level, the selling power or supply is extreme.
These two areas determine whether you need to open your position or close the one. On top of that, you know what is right for you when you closely monitor the price trend on the chart. Then, either you can short your position or hold it long according to the fundamentals, which are supply and demand.
There are three critical things where you need to focus while monitoring the support and resistance levels. These three are
The moment when the change in market trends takes place, prices bounce back at the support level. Breakout is the point from where the price starts rising or falling until a new support or resistance level is formed. Finally, consolidation is the scenario between both support and resistance levels.
How to identify the support and resistance levels?
The popular way to check support and resistance levels on the chart is technical analysis. There are several technical indicators that one can use to conduct technical analysis. Using the technical analysis, you can easily spot the resistance and support levels in the chart.
You can predict the best time to enter the market and open your position by conducting a technical analysis. Different strategies help you to understand various parameters of the market conditions that affect the supply and demand. Supply and demand are the major fundamentals of the price movements of an asset. When you know about the points where price breaks to change its direction towards uptrend or downtrend, it will be easier to get the most out of your investments.
Using several indicators, you can identify the support and resistance levels. Still, they get you confused in terms of other essential things like your mindset while trading because you need to be emotionally stable at the time of trading. One should not deviate from the strategy because of news and other market conditions. Choose one strategy and stick to it.
Identifying resistance and support levels helps to get the idea of where to place the stop-loss order in your trade. Stop-loss is reasonably necessary to avoid the situation of negative balance. When the price keeps falling, stop-loss helps protect your position by automatically closing your position if the price drops below the specific point.
We are classifying the ways to identify the support and resistance levels in three categories.
- Past data
- Existing support and resistance levels
- Technical indicators
Traders generally understand the patterns by using the previous price data. Previous uptrends and downtrends help traders to get an idea of current market conditions. Based on this analysis, one can quickly identify the support and resistance levels. Many traders only depend on historical price patterns and trade according to the current similar situations using support and resistance levels.
But to get success using this method, you need vast experience. As a beginner, only relying on historical data can be devastating for you. So beginners are advised to be aware of other methods to minimise the potential losses by carefully finding the support and resistance levels.
Existing support and resistance levels
This is again about reading the previous data, but this includes only examining previous support and resistance levels. It means that you may found the entry and exit points by looking at existing support and resistance levels. Use this strategy by not looking at them as the levels. Instead, it would help if you consider these as the areas – support and resistance areas.
This is because you cannot predict the exact entry and exit points, but you can easily identify the range for both of them. The market does not hit the exact figures again, and it is rare if you get to see that.
Technical indicators play a major role in identifying the possible support and resistance levels. There are two types of support and resistance lines.
- Static support and resistance lines
- Dynamic support and resistance lines
The difference between both kinds of support and resistance lines is that in static, you already know the support and resistance levels right from the beginning of your trading day while in dynamic, the levels are constantly changing according to price movements.
Technical indicators support both kinds of support and resistance lines. They are also categorised according to both static and dynamic. Here we are discussing the required technical indicators to draw the respective support and resistance lines.
Static support and resistance lines
To identify the approximate support and resistance areas, we can use the following methods.
Market swings: They will help you to get a rough idea of support and resistance levels. You just have to identify recent highs and lows in stocks or any other asset price and draw a line connecting the swings. If it turns out to be three or more swing levels, it will be an area of support and resistance.
Fibonacci retracement levels: This is one of the most common technical indicators used by traders to simplify the process of finding out the support and resistance levels. You can predict future support and resistance by looking at the retracement of the previous moves. For example, suppose the price moves up, and it follows the previous position after a certain time. That particular point gives you an idea of the next support or resistance level.
Round numbers: Traders tend to place stop loss and take profit close to the round numbers. This strategy gives you the most exact support and resistance levels. At round figures/numbers, the number of transactions is more. Because of high trading volume, they tend to give you more exact points of resistance and support.
Trend lines and channels: When you draw straight lines connecting previous support or resistance points of uptrend and downtrend, respectively, the line is called the trend line. While drawing the trend line, you need to ensure that you consider at least three peaks or troughs; it gives you the more relevant trend line.
Now you can conclude that the support level is the uptrend line, and the resistance level is the downtrend line.
Dynamic support and resistance lines
As the dynamic support and resistance levels keep changing as per the variation in market conditions, you cannot predict the exact entry and exit points.
You just have to use the technical indicator to determine the entry and exit points and stop-loss orders without manually adjusting the lines. So the various technical indicators are
Moving averages: Using this indicator, traders draw the line connecting the highest peak with the lowest peak. By doing this, they identify the direction of the trendline. Moving upwards is the indicator of a support level. And if the trendline is moving downwards, then it indicates the resistance level.
You can also use different moving averages to check what works best. Then, according to that one, you can open or close your position.
Bollinger bands: Bollinger bands is also one of the most used technical indicators among traders. This is also the most common indicator to satisfy the needs of predicting the support and resistance levels. Bollinger bands is the technical indicator that represents the simple moving average by various types of bands. There are three types of Bollinger bands – upper, middle and lower bands.
The upper Bollinger band indicates the dynamic support level and the lower Bollinger band indicates the dynamic resistance level. Bollinger bands have the ability to provide exact support and resistance levels. Professional traders generally use this technical indicator for their convenience to find the open and exit points and predict the price point where stop loss has to be placed.
There are some other indicators like Ichimoku cloud and Donchian channel but they are not as prevalent as the above technical indicators. The Donchian indicator is quite similar to the Bollinger bands.
How to trade support and resistance levels?
To get the best out of price movements, you can make a profit using the trend lines and place your trade accordingly. Traders wait for the trend line to hit the target at the support or resistance area and make the informed decision by understanding the situation to open their position. Whether you short your position or long your position, it also depends on the price movements.
The way you hold your position at a particular time depends on the range of the support and resistance levels. It is very essential to be aware of the market condition from time to time. So that you can make the best use of technical indicators to predict the future price movements. By improving your knowledge of support and resistance levels, you eliminate the major potential risks associated with your investment.
When the trend line is in place, you can capitalise on your investment at the right time. Traders collect profits when price movement hits the target defined support or resistance area.
Analogy of support and resistance levels
The analogy of support and resistance is quite similar to a room or hall where the ball keeps bouncing and touching the floor and ceiling. Here support means floor and resistance means ceiling. Here you can assume that a ball is bouncing in a hall and touches the ceiling and floor at times. You can understand the ball as the price of an asset. When the ball hits the floor means the price touches the support level and when it hits the ceiling means that the price hits the resistance level.
Now when the extra force is applied to the ball means that there is an activity of the bull or bear that influence the market conditions. When extra upward force is applied to the rubber ball, it rebounds back forcefully and vice versa. It clearly indicates that traders activity whether it is bullish or bearish affects the support and resistance levels from time to time.
Because of such conditions, the previous support becomes the new resistance level and the previous resistance becomes the new support level. So whenever you get confused with the theory of support and resistance level, you can easily understand this by the ball in a room with the floor and ceiling analogy.
Support and resistance levels are used as preliminary tools by some traders to minimise the risks and increase profits. You should get friendly with both these areas to gain more profit from your trades. Be specific while choosing the entry and exit points while trading. And to make the informed trading decision, support and resistance levels let you know about the stop loss placement also.
ABinvesting offers you the most favourable conditions for your trading at minimum costs and you can be assured that on the brokerage firm’s website, you will find multiple technical indicators that are discussed above to predict the support and resistance levels.