Understanding Support & Resistance Levels

The concept of SUPPORT and RESISTANCE is essential to understanding and interpreting price charts affectively.

Think of price charts as the result of SUPPLY and DEMAND of BUYERS, the “BULLS” and SELLERS, the “BEARS”. The bulls push prices higher and the bears push prices lower.

The direction prices actually move reveals what is the stronger factor, supply or demand in relation to each other.

In order to be successful at trading you need to supply or demand at the correct times.

Using this analogy, consider the price action of the price chart below. During the period shown, note how each time prices fell to the 8000 / 8100 level, the bulls i.e., the buyers took control and prevented prices from falling further.  This price action should inform traders that at these levels, bulls currently consider that going long is worthwhile and sellers are not willing to go short at lower levels. This type of price action is referred to as support, because buyers or the bulls are supporting the level.

Therefore support defines that level where buyers are strong enough to keep price from falling further or simply sellers may be unwilling to sell any lower and demand inevitably exceeds supply.  In the same way, resistance defines that level where sellers are too strong to allow price to rise further and buyers may not be willing to pay a higher price, supply inevitably exceeds demand. 

The Japanese Yen Continues



Support and resistance play different roles in up-trends and downtrends. In an up-trend, support is where a pullback from a rally should end. In a downtrend, resistance is where a pullback from a decline should end.  The last price at which a trade takes place is the last price at which a bull and bear agreed to do business and this price represents the consensus of their EXPECTATIONS. The bulls think prices will move higher and the bears think prices will move lower. 

Support and resistance are created because traders have a memory and expectation not “the market”. Those prices where major buyers or sellers entered the market in the past will tend to have the same expectations and this generates a similar mix of participants when price again returns to that level.  Nevertheless traders expectations change over time and in some cases very abruptly. Underlying fundamental changes that are above or below market expectations brings about these changes. The cause of these changes in expectations is not as significant as the effect as NEW EXPECTATIONS LEAD TO NEW PRICE LEVELS. 

Support and resistance come in all varieties and strengths. They most often manifest as horizontal price levels. But TREND-LINES at various angles represents support and resistance as well. Support and resistance exist in all TIME FRAMES and all MARKETS. The length of time that a support or resistance level exists determines the strength or weakness of that level. 
 
Therefore naturally levels in longer time frames are stronger than those in shorter time frames. Also, the greater volume traded at any level, the stronger that level will be. This strength or weakness determines how much buying or selling pressure will be required to break the level. Therefore a greater change in expectation is needed to break stronger supports or resistances.


 
Among various other tools, as mentioned trends as well as support and resistance can be measured using trend-lines. Very often a straight line can be drawn UNDER two, three or more pullbacks from rallies in an up-trend or OVER pullbacks from declines in down-trends.

When price then returns to that trend-line, it tends to find SUPPORT or RESISTANCE and bounce off the line in the direction of the trend.
However, once breached the trend-line acts as an apposing force.  In other words what once may have been support now becomes resistance and visa versa.

• When the market passes through resistance, that resistance now becomes support.
  
  
• When the market passes through support, that support now becomes resistance.
  
  
• The more often price tests a level of support or resistance without breaking it, the stronger that level becomes. When price breaks such a strong level of support or resistance, the stronger the break out will be.
  
  
• Such strong levels of resistance or support are called double tops, double bottoms, triple tops and triple bottoms. Of course, these patterns are interesting to be successful in our trading as they can create great opportunities in the FX market. If a currency pair is approaching an important support level, it can serve as an alert to be extra vigilant in looking for signs of increased buying pressure and a potential reversal.
  
  
• If a currency pair is approaching a resistance level, it can act as an alert to look for signs of increased selling pressure and potential reversal. If a support or resistance level is broken, it signals that the relationship between supply and demand has changed. A resistance breakout signals that demand (bulls) has gained the upper hand and a support break signals that supply (bears) has won the battle.