Support and resistance
A Wealth of Knowledge
As you may know by now that there are three schools of thought in trading. There are fundament traders, technical traders, and sentimental traders. These views, are different from each other in a sense that fundamental traders look at the economic data of a country. They take into consideration. The political stability of a country, economic growth, and social issues in making trading decisions. Where a technician and chartists will make trading decisions solely based on price movements in the charts, employing tools such as support and resistance candlestick formations, technicians will go further as to include an indicator to confirm their analysis. A sentimental trader trades based on the investors general feelings about a financial instrument. Say post-Brexit (A political, economic event whereby Britain opted to cut ties with the Euro zone members and to function on its own due economic reasons as well as political reasons). Such events do in fact affect the sentiment of financial instruments. For instance, George Soros speculated that should Brexit happen this will have a negative effect on Britain’s economy, people will lose their jobs, businesses will suffer and so forth. This is a sentiment he has on Pound Sterling. However, the purpose of this text is to explain support and resistance and how it can be used with candlesticks to form trade signals. So what are areas of support and resistance? This page seeks to explain support and resistance as well as give illustrations to graphically indicate these concepts on a chart so a reader may better comprehend such concepts in depth. Furthermore, an emphasis will also be placed on trend lines as to whether how one may draw them and or use them as part of their trading system.
What is Support?
So what is a support? Support is an area where the price cannot seem to penetrate or pass through as a result of buying power present in that area. This is called a support because sellers push the price down only to have it pushed back up by buyers in a way supporting the price as it falls back on that level. As a result, the price will seem to bounce at these levels and rally away from these areas in a chart. It is called a support area because sellers cannot seem to push prices below that certain area for some reason over time. This then becomes an area of interest which attracts more buyers than sellers. This happens when the instrument being traded is being valued by buyers and feel that they want to get it to a fair price/value. Look at the following picture as it further illustrates the point being raised.
Many books will go as far as associating support with a floor in a building. A resistance will be a roof or ceiling in this scenario. For one to dig through the floor and go under that floor you need a really powerful machine, equipment. Maybe a bulldozer to excavate through the floor. Now, think of the amount of fuel needed by these machines to do such work. Same thing applies in trading. In order for a significant support to be broken, we need a strong selling power. So, when the market touches a zone chances are, it will rally away from it as a result of a number of buyers stepping in at that level. Now it is a zone because the price will not always turn exactly at these points or levels. Sometimes it will bridge through as if breaking a line of support, therefore creating whipsaws to then only reverse back. This is how most traders get burnt. Because at times the support will look as if it is broken only to realize that the market was only testing it. Now with this being stated, it is also important to also state that a support is not broken until it is broken. Therefore it is vital that one understands that it is a zone and not necessarily a line so to speak. Now, look at these areas of support in a live chat. take a look at USD/CHF daily chart, every time the market touched the zone, the buyers stepped in to push prices high
So now that you understand what support is, or at the very least have an idea. Like everything else in life, support and resistance have rules to them. Those rules are as follows. The market should touch a zone at least twice for it to be considered as either a support or resistance. The second rule states that once a support has been broken it now turns into resistance. So a support once broken becomes a resistance, the opposite is true with resistance. Just to give you an idea I had prepared an illustration of this rule in play in the markets. Look at figure one, for instance, how when support is broken can now be regarded as resistance. This is an NZD/USD H4 chart. This happens most of the time if not all the time. For instance look at EUR/AUD weekly chart same thing again, support got broken then it turned into resistance.
So now that you at least understand the analogy behind support, it is now time to delve into resistance. The concept of "Resistance" will be explained below and hopefully one will understand these concepts in depth by the time they finish reading this article.
What is Resistance?
Often times when you hear the word "support" is often accompanied by the word "resistance". These two words contrast each other and so this is the case in trading. Resistance is the opposite of support in that, support attracts buying power, whereas resistance is the place in the charts where most sellers sell their shares. the buying power at play in the markets usually dies out at resistance. It dies out because more sellers come in the market. Either because they think the instrument being traded is overpriced/overvalued, therefore entering with the sole purpose to push price lower. This is called going "short" or "short selling". So what really is "resistance," you ask? Well, simply put, resistance is a price area where the price cannot seem to break/push above from as a result of selling power present at that price level. This area acts as somewhat a price barrier in that the price cannot seem to pass through. Areas of resistance seem to be demarcated areas on the charts, in that they mark a territory bulls have conquered the bears numerous times in a support and a place where the bears have conquered the bulls several times in a resistance area. So a resistance area is an area where price is being resisted by traders perhaps because they think it is too expensive and as they saying goes “buy low and sell high”. So if the price is deemed to be too high then what’s bound to happen in the forthcoming events? Short selling is imminent, bulls then would cash in on their profits and close their trades as a result of this phenomenon. Sellers will then step in, in an attempt to push price lower. The Bears or Sellers prevent the price from going any higher than it usually should. However, sometimes there could be more buyers than sellers which will result in sellers being overpowered which then would lead to resistance being broken and perhaps could be future support as already explained the role reversal nature of support and resistance.
Remember these areas of support and resistance are nothing but a battle for turf between bears and bulls. Of which at resistance bulls will tend to lose their strength because it was originally a bear’s turf, bears are stronger at resistance than anywhere else, provided that it is a bear market at that. Same applies to bulls, stronger at support given that it is a bullish market. Makes sense right? Hence the saying “the trend is your friend”, why would you want to sell short in a bullish market knowing that bulls are stronger than bears? The same is true in a bearish market, why buy when the bears are obviously dominating? It is knowing the market trends and where support and resistance are that you will be able to make informed trading decisions. So back to the building example where a support will be a building’s floor. A resistance in this scenario will be a ceiling or roof. Let’s say the building has several floors. What happens when one goes to the second floor? What used to be a ceiling is now a floor. What used to be resistance is now support. The market uses the same analogy as this. This is how the markets work and how they will probably always work, these rules are universal and are adapted to by most technical traders as the building blocks to understand price movement and forecast future price movements. In the case of a resistance being broken, it now turns into support. In contrast to a support being broken in which case it will then turn into resistance.
Trendlines are nothing more than lines connecting highs to highs. These are lines drawn by traders by simply connecting lows to lows or highs to highs. This thus gives the traders an idea of where the price is headed, hence the word trend lines. This enables traders to gauge price movement as well as determines trend direction. So this is what is meant by the word price action. it encompasses trading merely using candlestick patterns, support, resistance, and trendlines. This type of trading was used by chartists and veteran traders and it is still befitting to the markets to this day. So trend lines can also be used to draw channels, which is basically drawing trend lines on either side of the price, connecting lows to lows and highs to highs in that fashion. They can also act as support and resistance too, think about it, every time the price touches a trend line it changes its direction or reverses. So without further ado, here is an example on trendlines. Now, trend lines, when used correctly alongside with candlestick patterns as well as support and resistance, make a good trading strategy and a simple one at that.
this is how it all comes together in making trading decisions, everything explained thus far is cumulative. one should read further for a more in depth understanding of these concepts.
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