Trading with Support and Resistance: A Comprehensive Guide

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Support and Resistance are powerful tools in trading, utilized extensively across various strategies to some extent. These levels often appear around crucial areas where the price frequently touches and then reverses. This article explains what Support and Resistance are and introduces common trading strategies using these concepts.

What are Support and Resistance?

Support and Resistance are widely used concepts in technical analysis within the financial markets. These tools help traders analyze charts quickly to identify three key elements:

• Market direction
• Entry points
• Exit points, regardless of profit or loss

If a trader can answer these three questions, they essentially have a trading idea. Identifying Support and Resistance levels on a chart can help provide these answers.

Support

Support is an area on the chart where the price drops but struggles to fall below. The chart above demonstrates how the price drops to the Support level and then “bounces” back up strongly.

In theory, Support is the price level at which demand (buying interest) is strong enough to prevent the price from falling further. The rationale is that as the price approaches the Support level and becomes “cheaper,” buyers perceive it as a bargain and are more likely to buy. Sellers are less inclined to sell at this lower price. In this scenario, demand (buyers) will exceed supply (sellers), preventing the price from falling below the Support level.

Resistance

Resistance is an area on the chart where the price rises but struggles to go above. The chart above shows how the price rises to the Resistance level and then “bounces” back down strongly.

In theory, Resistance is the price level at which supply (selling interest) is strong enough to prevent the price from rising further. The rationale is that as the price approaches the Resistance level and becomes “expensive,” sellers are more likely to sell at this higher price, while buyers are less inclined to buy. In this scenario, supply (sellers) will exceed demand (buyers), preventing the price from rising above the Resistance level.

4 Popular Trading Strategies Using Support and Resistance

Here are four common trading strategies involving Support and Resistance:

1. Range Trading Range trading occurs within the price range between Support and Resistance, where traders aim to buy at the Support level and sell at the Resistance level. Imagine the area between Support and Resistance as a room, with Support as the floor and Resistance as the ceiling. A range appears when the market is moving sideways without a clear trend.

Trading Tip: Support and Resistance are not always precise price levels. Sometimes, the price will bounce from a “zone” rather than a specific price point. Traders need to identify the trading range by marking the relevant Support and Resistance zones. In a ranging market, traders typically look for buying opportunities near Support and selling opportunities near Resistance. Prices do not always “respect” these zones, so traders should consider placing stop-loss orders below Support for long positions and above Resistance for short positions.

When the price breaks out of the range, it could be a genuine breakout or a fakeout. Applying appropriate risk management measures is crucial to limit losses when the market breaks the trading range.

2. Breakout Trading Often, after a period of sideways movement, the price will break out and start trending. Traders look for such breakouts below Support or above Resistance to capitalize on further upward or downward momentum. If the momentum is strong enough, it can potentially develop into a new trend.

However, to avoid falling into the trap of false breakouts, experienced traders often wait for a pullback to the Support or Resistance level before entering a position. For instance, the chart below shows a strong Support level before sellers push the price below that zone. Instead of rushing into a short position, traders should wait for the market to react (buyers trying to regain control) to break through the former Support level before going short.

Example: Wait for pullbacks before entering trades to confirm the breakout’s validity.

3. Trendline Trading This strategy involves using trendlines as dynamic Support or Resistance levels. Simply draw a line connecting two (or more) highs in a downtrend or two (or more) lows in an uptrend. In a strong trend, the price will bounce off the trendline and continue moving in the direction of the primary trend. Thus, traders should only look for entry opportunities aligned with the primary trend to increase the probability of success.

Example: Only seek entry opportunities aligned with the primary trend for higher win probabilities.

4. Moving Average (MA) as Support and Resistance Moving averages can serve as dynamic Support and Resistance levels. Popular moving averages include the 20 and 50-period MAs, which can be adjusted slightly to 21 and 55 periods based on Fibonacci numbers. Many traders also combine the 100 and 200 MAs. You need to find a setup that suits your trading style.

Example: From the chart below, the 55-period MA initially acts as a Resistance level. The market then bottoms out and reverses, turning the 55-period MA into a dynamic Support level. Traders can use these moving averages to make decisions about the market’s continuation or reversal.

Key Points to Remember When Using Support and Resistance

• Support and Resistance are powerful tools in trading, and most strategies incorporate Support/Resistance analysis to some degree.
• Strategies using Support and Resistance can be based on price “respecting” these levels (range trading) or anticipating breaks of these levels (breakout trading).
• Prices do not always “respect” Support and Resistance levels. Therefore, traders need to combine them with proper risk management measures to limit losses if the price moves against their expectations.