Technical Analysis Series — Article #1: Support and Resistance
Key Terms
Support: An area or a level where the price is supported (holds) and does not break below it.
Resistance: An area or a level where the price resists (rejects) and does not break above it.
Stop-Loss: A specific type of order used to exit out of a trade if a certain price is hit, meant for preventing further losses.
One of the most important aspects of technical analysis is Support and Resistance.
Support and resistance lines are levels that can be used to look at trends of the market. This knowledge will carry over to other aspects of technical analysis, and is arguably one of the most important skills you would use in price action trading.
First off, what are support and resistance levels, and how can you identify them?
Support levels are an area where the market holds and bounces off of, as in that zone there is more demand than supply — more buyers than sellers. Resistance levels are similar, they are an area where the market rejects, and in that zone there is more supply than demand — more sellers than buyers.
In Figure 1 below, I have pointed out many of the multiple support areas (green) and resistance areas (red).
How do you draw them?
There are generally two types of support and resistance lines that are drawn:
1. Flat horizontal lines, usually used for showing support / resistance zones.
2. Trendlines to highlight how, and where the market is trending.
In order to draw the flat horizontal variation, you find a point where there is a strong support / resistance zone, and place the line there (as seen in Figure 1).
In order to draw the trendline, you must find a minimum of two points where there is either resistance or support. Since the goal is to find a trend for these supports/resistances, you will then connect these points, with more points indicating a stronger trend.
There are generally three main ways to use support and resistance:
1. To enter a trade anticipating a reversal, as there was not enough momentum to cause a breakout. (Figure 2).
2. To enter a trade once a breakout occurs in anticipation for a strong move in the direction that it breaks (Figure 3).
3. To place stop-losses in order to prevent further loses when the market turns against you (Figure 4). This is similar to #2, but for exiting a losing trade going in a direction against you.
Examples
In this chart of NVIDIA (NVDA), a horizontal resistance level and support trendline is drawn (Figure 5).
In order to trade the resistance level, you could either sell against it with a stop-loss above it, or buy once it breaks out with a stop-loss below the resistance level. In both cases, the stop-loss would have protected you from further losses from the fake out near 2007–2008, allowing you to reenter a trade at a later date before the major breakout in 2016. This resistance level also shows the concept of support becoming resistance, and resistance becoming support. During the fakeout, it became a zone that temporarily held price action, which can also be seen during the breakout before it started to reach new highs.
In order to trade the support trendline, you could buy when price action hits it and then place a stop-loss (such as $5.60 if you bought during November 2008) for when price action breaks below the support trendline. You could also sell when the trend breaks, as it would indicate that the market would be turning bearish (in this case the support line did not break).
Those who may recognize these trendlines to form a shape of an ascending triangle, would be right. However patterns are a different topic, which may be discussed separately.
In this chart of the S&P 500 (SPX), a resistance trendline is drawn using the three peaks (Figure 6). In order to trade this, you would wait for the price to breakout of the resistance trendline before buying, with a stop-loss to cut your losses in case it’s a fakeout. This stop-loss would be placed under the trendline.
In this chart of Gold (XAUUSD), we are able to draw a support and resistance trend line that forms a channel (Figure 7). The channel forms a pattern called a “falling wedge” which is generally bullish. After the pattern breaks out, the resistance level is retested with the concept of resistance becoming support. In order to trade this, you would buy if the resistance level of the pattern breaks out with stop-losses if price action re-enters the channel, or you would sell if the support level breaks down, with a stop-loss if price action goes back up into the channel.
In Bitcoin (BTCUSD) (Figure 8), we are able to draw a resistance trendline against the four peaks. In order to trade this, you would place orders above one of the peaks to buy in once the resistance trendline breaks out. In this case I’ve placed a green horizontal resistance line against one of them, (which also has two touches indicating it is a strong resistance level). For a stop-loss, you would sell if price action breaks back below the resistance trendline. Alternatively, you could sell once price action goes below the green resistance line (as resistance can become support, and if it breaks the support line it would be bearish. In the previous example of Gold, placing a stop-loss below a horizontal resistance trendline would not have worked, however it would have still been a good idea to do so in order to cut losses as fast as possible, in case it didn’t bounce off the trend line.
Sounds Easy?
Don’t be fooled. Trading is not as easy as this, and is a discipline that requires extensive learning. The truth is that 90% of traders lose money. However, with training and proper money management, you are able to be in the 10% that do not. Always have a trading plan, use stop-losses to cut your losses and move on, and never trade greedily.
This is the author’s perspective and is meant to be used for educational purposes. This is not financial advice.
Written by Fahim Ahmed, Writer for the Junior Economist
Originally published on September 27th, 2019
