Why Support And Resistance Level Is Essential For Traders

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Support and Resistance: Trading Basics Tutorial

Support and resistance levels are significant levels on the asset chart that the price has a chance of retracing from. Trading on breakouts and trend reversals is a popular method of choosing market entries.

Support and resistance lines are the most obvious technical analysis indicator. At the very least, you should give them a chance because a lot of investors and traders all over the world rely on them daily.

Support and resistance lines on the chart

You can draw these lines on any kind of chart: bar, candlestick, area, or line. But as with other forms of technical analysis, they are the most visible on candlestick and bar charts. Support and resistance levels can help traders figure out at what point to purchase an asset with a falling price, and when to consider selling it.

As you can see, support and resistance levels reflect peaks and troughs on the price chart. These local price extremes are the foundation of trading. They reflect the law of the financial market – seller supply and buyer demand. Support and resistance levels are formed on the chart because bidders are guided by the price level that the price reached the last time. They do not want to take risks, and begin to get rid of their current positions at a safer level.

Traders who use support and resistance levels have strategies in their arsenal both for rebounds from the level and breakouts of the level.

Rebounds

When the price approaches levels that it bounced back from in the past, it can rebound again, thus forming a price channel.

The picture above shows the price movement in a flat with clear boundaries. The upper limit of the flat serves as resistance for the market, and the lower limit – as support. Some traders treat the rebound as an entry opportunity, closing the deal when the price gets to the upper boundary.

Similarly, an entry point for selling is the moment of rebound from the level of resistance at the upper edge, exiting the deal at the support level. In addition to the horizontal levels of support and resistance, there are also inclined levels. These are called trend lines.

The trend line and the level of support form a triangle

Trend lines indicate the direction of price movement. They are built using the local maximums of the downtrend and minimums of the uptrend. Note that you can also add horizontal levels on the price chart as a part of the general strategy.

Potential entry points on horizontal levels

It is also possible for an old resistance level to turn into a new support line (when the asset price goes up), and vice versa for a downward price movement. Retracements in the direction of the trend can be treated as one of the signals. If the retracement is stronger and the price breaks through the trend support, traders consider applying a strategy based on breaking out of the support and resistance levels.

Breakouts

Support and resistance breakouts sometimes offer an opportunity to ride a strong trend. Note that this technique is harder to use than the previous one, because the trader needs to watch the market almost constantly so as not to miss an entry point. Many traders who take advantage of the breakout don’t enter immediately, but wait for the retracement after the breakout, and only then make their entry.

Entering the market after a breakout retracement

Fakeout

Breakouts of the support and resistance levels can be real or fake. False breakouts often mislead traders, since the price broke through the level and should be on a good wave, but it turns out exactly the opposite – the price goes back behind the level and heads in the opposite direction.

In such cases it is best to wait until the close of the next candlestick after the break and analyze the market situation. If the price comes back after the breakout and the candlestick is drawn opposite to the breakout, then this is probably a fakeout.

In the event of a true breakout of the trend, some traders prefer to enter with the retracement after the breakout.

Conclusion

Trading on support and resistance levels takes advantage of the psychology of the masses — market participants focus on how the price behaved in a similar situation in the past. They measure the maximum and minimum prices over the current time interval (for example, over the past week), and evaluate events that took place during this time or that might occur in the near future. If the background information related to the asset doesn’t suggest any disturbances and there aren’t any events that would affect the asset more than in the past week, it is logical to assume that the price will remain in the same corridor going forward.

To trade using this method, you need to learn how to build support and resistance lines and monitor the background news to avoid running into an unexpected breakout. Remember that no technical analysis instrument is 100% accurate, as all of them can provide false signals.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
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Why Support And Resistance Level Is Essential For Traders

The following article on How to Trade with Support and Resistance Levels is the opinion of Optimus Futures.

Support and Resistance levels are concepts that are so fundamental to technical analysis that any lack of understanding in their formations and indications may serve a major impediment to any trader’s technical progress. This article has two general goals: first, it aims to cover the basic concepts surrounding support and resistance; and second, it aims to provide a few tips on how to use support and resistance levels in your trading.

What Are Support and Resistance Levels?

Support and resistance points at which price trends reach a temporary limit, either to reverse or continue in the direction of the original trend. Why do prices reach this limit? Because demand has increased above supply (support), or supply has increased over demand (resistance).

In the market, prices are driven by either excessive supply, causing prices to trend downward, or excessive demand, causing prices to trend upward.

As the demand for a futures contract increases, bulls take over, bidding prices upward.

When supply increases, the bears take center stage, their selling activity pushing prices down, as there are now fewer buyers willing to purchase a given futures contract at a higher price.

Support and resistance levels act like invisible barriers, preventing prices from moving past them. To get a more comprehensive understanding let’s discuss each level in detail, starting again with support.

Support 101

Support is a level at which a downtrending price movement stops momentarily. Theoretically, support is where a large number of buyers enter the market, overwhelming the number of sellers. In short, demand overwhelms supply, bidding prices higher, causing a price decline to halt, or reverse and move higher.

Support levels are not impassible–in many cases, they can merely be temporary. An eventual break below support indicates a new level at which people are willing to sell. Often, once support has been broken, a new support level will be established at a lower price point.

Although there is no way to mathematically predict where the next support level may occur, historical support levels are likely candidates for future support levels (hence the saying that the market has a memory).

Resistance 101

Resistance is the exact opposite of support. The resistance level is a point where selling is thought to be strong enough to prevent the price from moving any higher. The logic behind resistance is that more sellers have entered the market than buyers. Hence, the price of a futures contract is no longer bid upwards, but downward.

Imagine an auction where buyers are bidding for a limited number of products. Prices are moving higher as the limited supply tightens. Now imagine if a seller came in with a huge supply as the product is bid higher. At that point, buyers–realizing there’s more supply than demand–will have the sense to bid at lower prices, moving prices downward. The point at which price reversed–the level at which more supply entered the market–is what is referred to as resistance.

When the resistance barrier has been breached, a new resistance level will eventually be established at a higher level.

Futures can undergo periods of proportional trends, repeatedly hitting resistance and support lines until it is either broken or it causes price to move in the opposite direction.

How to Find Support and Resistance Levels

There is no definitive formula or algorithm to calculate support and resistance. Perhaps the easiest way to identify support and resistance is to simply use your eyes.

When a support or resistance level has been breached, price moving past the initial barrier, it is said that the old resistance level becomes the new support. On the reverse side, support that is breached may become the new resistance line.

When the markets begin to move side-ways within a range, this is typically taken to indicate that the market is evenly balanced between supply and demand. When the price moves outside of that tight-knit sideways movement, it will signal whether the bulls or bears have won. When such a breakout occurs on high volume, the outcome will likely result in a prominent move up or down–a new (and possibly strong) trend.

If you want confirmation or an additional source, you can access dynamic support and resistance levels through the Optimus News platform (free for customers). Optimus News’ Dynamic Support and Resistance Levels is able to automatically draw support and resistance for any instrument (levels prices based on spot prices and not futures prices). Levels are generated four times a day which allows our customers to have real-time, up-to-date analysis on price movements. Here is a quick overview in this video.

How to Trade Futures Using Support and Resistance Levels

The practical benefit of using support and resistance is that it can easily combine with other approaches, from strict price action to indicator-based systems. Support and resistance is a very straightforward concept as just about anybody can start drawing horizontal lines on their charts and see how price bounces off of these levels.

As with any indicator, support and resistance is not 100% reliable–but when they are not, the breaches provide critical market information that is equally actionable. Let’s dig a little deeper into some tactics concerning this matter.

Lines vs. Zones

The biggest misconception is that support and resistance levels are single lines that can be drawn at specific prices. Although it is possible to draw support and resistance using single lines, this approach leads to very inconsistent trading results. Instead, think of support and resistance as zones rather than lines based on a single price point.

The S&P 500 chart below illustrates the concept of support and resistance zones nicely. As you can see, there are 3 resistance zones stacked above each other. So which one is the right level to trade off? The answer is, all resistance levels are equally correct and the one you choose depends on your personal preferences and your psychology.

Aggressive – neutral – conservative
In the case of a resistance level, let’s assume that you are looking to sell when the price reaches one of three resistance levels. But which one would you choose? It all depends on the risk you are willing to take:

Aggressive
If you take the first resistance level, you run the risk of getting stopped out should price continue toward the higher resistance levels. This strategy is ideal for traders who not only want to enter sooner rather than later (out of fear of missing a trade) but can also withstand a lower win rate.

Conservative
This level is the farthest away, meaning that the price may not reach that level as often as the lower resistance zones. A conservative approach is ideal for the risk-averse trader who would prefer a higher win-rate, but at the expense of missing (more aggressive) trades.

Neutral
The neutral level where most traders tend to feel comfortable. It is a good compromise between an aggressive strategy where you will experience frequent losses and a conservative approach where you will often miss trade entries.

Pro Tip: Even if you only see 2 clear support or resistance levels on your charts, you can draw an additional line in the middle and create the ‘neutral’ zone.

Multiple entries using the three-level-concept

If you feel that picking only one level alone does not sound like a good enough strategy, there is another possibility how you can use the concept of support and resistance zones. If we go back to our previous example, you can use the three levels to split your order among the different areas. Again, there are many ways to go about it, none of which can be considered ‘right or wrong’.

For example, if you want to risk 3% on the trade in total, you could enter three different positions, using 1% on each entry. Note that there are multiple ways to structure your position size using the concept of support and resistance zones. Our suggestion is merely one way to do it.

Another example: a more aggressive trader might enter the majority of his position on the first level while a conservative trader might only use a small part of his total position on the first two levels.

Support and Resistance Trading Strategies

Support and resistance may look simple, but when it comes to making actual trading decisions, most traders would agree that it’s not as easy. The next 6 tips in this article can help take your support and resistance trading to the next level while avoiding common mistakes.

Most traders use wicks and candle extremes when drawing support and resistance levels. However, candle bodies represent closing times and on the daily, weekly or monthly charts, drawing support and resistance on the candle bodies can help you understand price moves in a new way.

Taking a top-down approach to market analysis, start on the higher time frame and work your way down to the lower time frames. On the higher time frame, you start drawing your levels using the bodies and the major swing points. As you move lower, fine-tune and adjust your levels. This should help you end up with a very accurate way of explaining past price action with optimized levels.

In the end, there is no right or wrong way to do this, you only have to make sure that you are following a consistent approach.

Is past price action more or less important than recent price behavior? This is a question most traders have and it’s important to understand the implications correctly. You may see situations in which strong support and resistance areas have worked perfectly in the past, only to be violated in later periods.

For that reason alone, it’s important to keep updating your support and resistance levels. We recommend going over all your levels at least once per week (more often if you are a day trader) and check whether the markets are still paying attention to the levels on your charts.

Support and resistance levels only show potential price areas of interest, but if markets don’t respect them, you need to update and adjust them in order to make correct trading decisions. Also, you should take off old support and resistance levels if they are no longer relevant to prevent them from distracting you during your analysis.

The price goes from respecting a level, to neglecting it, back to respecting it.

Conventional trading wisdom will tell you that the more touches you have on a price level, the stronger it may be. However, conventional wisdom is seldom right, and when it comes to making general assumptions, listening to such suggestions can lead to bad trading results.

All you need for a support and resistance level is one previous swing high or low. Meaningful swing highs and lows often turn into support and resistance levels in the future. However, the third time price comes back to a level, it tends not to hold as well, often resulting in a breach.

A good rule of thumb is that the more obvious something appears on your charts, the harder it usually is to profit from it.

The third point is usually faked when it becomes too obvious.

This is something that’s often overlooked in conventional technical analysis. Support and resistance rarely come in the form of single lines. This notion of single support lines has contributed to many poor trading results among various other problems. It’s simply a bad yet common fallacy.

More often than not, you’ll find support and resistance to occupy wider “zones” rather than single lines. Whereas traders who trade off of single lines can be taken out by volatility spikes easily, or miss moves when price does not reach their level, traders who follow wider price zones avoid many of those common problems.

Pro Tip: Draw multiple lines around a support and resistance area to capture the most price action. Then, avoid any price moves that happen inside the area as those signals are usually less reliant.

Areas explain more price movements and filter out whipsawing price.

It’s common practice to place pending orders ahead of support and resistance levels and then just wait for the price to get there, hoping to see a bounce or a break. Again, support and resistance levels just show potential, and it’s usually impossible to make predictions about whether a level will hold or break.

The advanced trader will wait for the price to reach his pre-marked levels before analyzing price action. The way price moves into the level, how it behaves there, and the general market context–all of these are important clues that need to be taken into consideration when trading support and resistance. Making predictions with pending orders may not be the most optimal approach..

Placing stop losses right at support and resistance is another problem many traders have. Traders believe that the more obvious the level, the better it is – that’s what trading books teach you right?! However, when the majority of traders look at the same level with the same trade idea, it becomes very easy for the advanced traders to use this knowledge to their advantage.

This flawed assumption is often the very reason why you see volatility spikes and fake breakouts around major support and resistance levels–the professionals move price in a way so that they trick amateurs into taking unprofitable trades.

Instead, wait for the dust to settle and only trade when the price has established a clear sense of direction.

Conclusion

While there is no exact science to establish support and resistance levels, it is essential to understand what they mean, how they work, and most importantly, how to use them. Uncovering support and resistance levels patterns and plotting them on your own may be difficult, but if used properly, they can help you set up more profitable trades.

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. The placement of contingent orders by you, your broker, or trading advisor, such as a “stop-loss” or “stop-limit” orders will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.

Please be advised that trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. This matter is intended as a solicitation to trade.

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  • The Most Valuable Support and Resistance Levels in Forex & CFD Trading

    Have you ever asked yourself which support and resistance levels are the most valuable when analysing Forex, CFDs, and commodities charts amongst others? Not all support and resistance (S&R) levels have the same value in all situations. Some zones are critical for breakouts, whereas others play a key role in reversals. Today’s article explains which S&R levels are the best, most reliable, and easiest to use in different scenarios.

    What is the Main Purpose of Support and Resistance?

    S&R provides analysts and traders with a key overview of the most important levels in the market, and on the charts. These S&R zones are derived from bouncing spots from the past. Basically, the price reaches a spot where it reverses into the opposite direction, which in turn creates a S&R level. S&R levels are a commonly used element within the field of technical analysis, together with trend and price patterns. The seven main benefits of using S&R zones are summarised below. Support and resistance plays a key role in:

    1. Identifying bounce or reversal spots
    2. Measuring breakouts
    3. Trading breakouts
    4. Trading bounces
    5. Finding targets
    6. Avoiding weak setups just before S&R
    7. Adding confluence to your analysis

    Source: Data Range: 14 – 24 August 2020 – displaying 1 hour chart – EUR/USD – MetaTrader SE platform

    Source: Data Range: March 2020 – August 2020 – displaying daily chart – EUR/USD – MetaTrader SE platform

    What Types of S&R Levels Exist?

    There are various types of S&R levels. All three groups are equally useful, but traders tend to develop a personal preference for one or two of them. The three main S&R levels are:

    • Fixed S&R levels
    • Dynamic S&R levels
    • Semi-dynamic S&R levels

    Fixed S&R Levels

    Fixed levels are S&R zones which are not changed. They remain valid at the same level, unless the price breaks through it. Examples of fixed levels include: tops and bottoms, round levels, yearly highs & lows, candle highs & lows, and candle opens & closes. All of these levels do not change, they remain the same no matter how the price moves. A round level of 1.10 will remain 1.10, and will not change to 1.1050. Do keep in mind that all S&R levels are rough zones, and not precise. Even though the round level of 1.10 will not change, its effect is not only noticeable at 1.10. In fact, the price can already reverse and bounce around, near to 1.10, at points such as 1.0975 and 1.1025.

    Dynamic S&R Levels

    Dynamic levels are S&R zones that change. Each time a new candle, bar, or any other unit of price arrives on the chart, the S&R level is recalculated, and a trader will use the new level for their decisions, and not the previous one. Examples of dynamic S&R levels are: moving averages, the parabolic, the Admiral Keltner Channel, and the Ichimoku.

    Semi-dynamic S&R Levels

    Semi-dynamics S&R levels are in between fixed and dynamic levels. Whereas dynamic levels change at different rates, and fixed levels remain constant, semi-dynamic S&R levels change at a constant rate. A perfect example of a semi-dynamic S&R level is the trend line, which changes at a fixed rate per candle. If it is placed with an up or down angle, the trend line will move at the same rate into that direction, with each new candle. Other examples include Fibonacci levels (which can be moved by the trader) and Pivot Points (re-calculated automatically depending on the period).

    The main difference between dynamic and semi-dynamic levels is the fact that semi-dynamic levels only change at a fixed rate per candle, whereas dynamic levels change at a non-fixed (flexible) rate. Depending on the method used, the S&R levels can either be automated, or drawn manually on the chart. The Fibonacci retracement tool needs to be drawn manually on the chart by the trader, whereas a moving average is calculated automatically by the MT4 or MT5 platform once it has been added to the chart.

    Source: Data Range: March 2020 – August 2020 – displaying daily chart – EUR/USD – MetaTrader SE platform

    What is the Best Way of Using S&R Levels?

    The best method is to use S&R levels on multiple time frames for different purposes. Although traders can use as many time frames as they want, the best approach is usually to work with three charts. More than three time frames often becomes confusing, and less than three charts provides less depth and insight. Let’s divide the three time frames into higher, middle, and lower time frames, because the three time frames that are used do mainly depend on what type of trader you are. Logically, a long-term trader will use a different set of charts to an intra-day trader.

    Let’s provide a summary for each trader type.

    1. Long-term trader:
      1. Higher: monthly chart
      2. Middle: weekly chart
      3. Lower: daily chart
    2. Swing trader:
      1. Higher: weekly chart
      2. Middle: daily chart
      3. Lower: 4 hour chart
    3. Intra week trader:
      1. Higher: daily chart
      2. Middle: 4 hour chart
      3. Lower: 1 hour chart
    4. Intra day trader:
      1. Higher: daily chart
      2. Middle: 1 hour chart
      3. Lower: 15 minute chart
    5. Scalping trader:
      1. Higher: 4 hour and/or daily chart
      2. Middle: 15 minute chart
      3. Lower: 5 minute chart

    The higher time frames are the most suitable for finding critical levels, which are strong enough to stop a trend or impulsive price action from continuing. These are the levels that traders must observe for potential reversals and use for targeting, but they must be careful when trading into these levels when the price is nearby. The middle time frames are more suitable for finding continuations or breakout spots for the trend, or tops & bottoms within a range. These levels are not as huge, strong, and important as the S&R levels of the higher time frame, and are best used for bounces at retracement levels, or with the trend breakouts.

    Lower time frames are even less stronger than the middle time frame ones, and are best used for trading breakouts only. Traders can trade breakouts that are both with and against the trend, or breakouts that are above or below ranges. Once the price breaks through a S&R level on the lower time frame, it could be used for a reversal setup if the larger analysis confirms that a larger reversal is possible or likely.

    What are the Best Tools for Support and Resistance?

    Every trader will have their own personal preferences for support and resistance tools. Some traders will only use Fibonacci levels, whereas others might use a mixture of moving averages and pivot points. Simply put, there is no right or wrong answer. The best method is to find the S&R tool or tools that work best for your trading psychology, and with your trading method and system. The preferences are highly individual, which is why testing the S&R levels of a few days and even weeks makes sense. Why? Because a S&R tool that might work well for one person, might also work well for you and vice versa.

    Choosing the support and resistance tool of your choice typically plays out in the following stages:

    • Testing and trying phase: open up and try out as many S&R tools and indicators as you want. There are no limits here, as you can playfully test and work with all the different S&R levels. There are many indicators available, so take your time to check them all out, and write down the ones that seem the most interesting to you.
    • Research the chosen tools: once you have made a short-list of the tools and indicators that seem to be the most interesting to you, take time to understand them in more depth. Make sure to do some research so you know all the rules and ideas behind it. Make sure that you check all and any assumptions associated with them.
    • Practice and test with the tool: once you have narrowed down the list to just a few, and you understand the S&R tools and indicators at a more advanced level , it’s time for the next phase, which is to practice and test these S&R tools. Try to acquire a better feeling of and understanding for the methods that work well with those S&R levels.
    • Make your final decision: choose the S&R tools that work best for your trading strategy, trading psychology, and your allowed time.
    • Integration into your trading plan: after the testing phase has been completed, you need to make sure that the S&R tool is fully integrated into your trading plan, so ask yourself the following questions:
      • Is the S&R tool fully understood?
      • How do you use it? Is the role of the S&R tool clear?
      • When do you use it? Are there times or exceptions when do you not use it?
      • Is the tool used in conjunction with other tools?

    This is the best method for finding your favourite S&R tools and indicators, but there are a couple of tools and indicators that do appear to be more popular. Here is a short list of the most popular ones:

    1. Fibonacci
    2. Moving averages
    3. Round levels
    4. Trend lines & channels
    5. Pivot Points
    6. Price bands (e.g. Admiral Markets Keltner channel)
    7. Fractals, tops & bottoms

    Conclusion

    Every trader must find the best support and resistance tools, concepts, and indicators that help and boost their trading in the most effective way. This of course can vary strongly from one trader to the next. It is important therefore, to first test the various S&R tools and indicators, and then find the one(s) that match your style. There are three groups of tools: fixed S&R levels, dynamic S&R levels, and semi-dynamic S&R levels.

    Keep in mind that S&R levels are best used when they are applied with different strategic goals on three different time frames: the highest, the middle, and the lowest time frame charts. S&R levels are important for identifying bounce or reversal spots, measuring breakouts, trading breakouts, trading bounces, finding targets, avoiding weak setups just before S&R, and adding confluence to your analyses.

    This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

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