Part 1 - Why does Support Resistance Exist

Support and resistance are technical areas where the market stops and reverses. Technical Support Resistance is an important factor in technical analysis. The idea of Supporting Resistance is simple, but going into it we will find a lot of issues worth discussing.

This article is a detailed guide on how to identify Resistance Support and how to trade with them.

Let's first reiterate the definition of Resistance Support:
  • Support is an area where potential buying pressure exists. When the market dips to a specific area, this buying pressure causes the price to rise again.
  • Resistance is an area where potential selling pressure exists. When the market moves to a specific area, these selling forces will cause prices to fall back.
Support and resistance levels are typically the results of large institutions buying and selling in their target price ranges.

Breakdown, Breakthrough, and Rejection

When the price reaches resistance support, there are 2 possible scenarios:
  1. The first is that the price bounces back or gets rejected there. Sometimes it reacts correctly and reverses, but sometimes the price can go past the resistance support and be rejected there.
  2. The second case is the price crashing through the resistance support. If the price penetrates the resistance, we call it a breakthrough and still penetrate the support level called a breakdown. However, we just call it breaking down for easy asthma.
One thing that complicates support is that it's not always the same. They are formed in many ways, and each has a different representation on the price chart. You see a few examples below:


The figure above shows that support is the horizontal blue line. There are times when the price bounces back from this support, sometimes it gets pierced. In the next section, we will explore why when resistance is broken, it becomes support and vice versa. It means that a price zone can be both a resistance and a support level.

But, a supportive resistance can also appear in many different price zones. As shown below:


The figure above shows supports for forming a sideways price zone. The price fluctuates in these 2 thresholds. But sometimes the price also acts within the parallel resistance support in an up or down direction as shown below:


The examples above are not the whole way to support the resistance is shown. Those are the most common ways only.

Why does support resistance exist?

Investors and traders for large institutions often determine the target price for the products they are going to trade-in. On the stock market, for example, about 5 million Amazon shares are traded at $ 3,250 per share per day. Similar sugar 16.25 billion USD daily. And the large organizations that hold them are not small traders.

So a support and resistance level can be represented on a chart in many ways, but they exist because of two factors: fundamental and psychological.

Basic factor

In large institutions, they will not decide to trade if they do not have prior research. When a stock or currency hits the bid, they buy. When this position reaches their target, they sell. But one thing that we need to keep in mind is that their transaction size is huge. This is the biggest challenge for institutional traders.

Another challenge is that large institutions have to buy or sell large volumes of stock without causing the market to move too much, slippage, or cause market to wobble.

To overcome these two things, large organizations buy and sell stocks at many different times. That is why resistance was formed.

Psychological factors

Large organizations have strict processes around transaction execution, and they just divert away from these processes with an unacceptably high risk. For example Covid-19.

Although most traders have psychological problems trading, most of these emotions do not happen at the level that large organizations care about. But there are cases where the sentiment comes into play, such as the strength of the basic news or the 52-week low.

P2 - How to identify strong support resistance

Supporting resistance can switch roles

We also know that resistance has a reversal. When support is broken, it becomes resistance and vice versa. As shown below:


How to identify support and resistance

There are many ways to identify resistance, but the ones below are the most common:

Use pivot points

A bottom is the easiest way to identify potential resistance support. As shown below:


And if these points are not easy to determine, they are ineffective. In fact the opposite. The more obvious a support resistance makes them even more effective.

Trendline

Trendlines are also a simple way of identifying support and resistance. The trendline connected by the lows is considered the threshold of support. The top trendline is considered a resistance. And be careful not to draw a trendline that crosses the price action of the market. See the picture below:


Average line

This is how many traders use it. Traders who trade on the low timeframe use the 200 SMA as the dynamic resistance support. This is also an important indicator of Paul Tudor Jones.

Short-term traders often use the 12/26 EMA as a potential support resistance. As shown below:


Using moving averages will limit your subjective identification of support.

Other factors for assessing a strong support resistance

There are five factors that traders should consider when identifying strong support and resistance:

1. Time

As time goes by, a supportive resistance usually becomes less strong. If an institution is accumulating shares at a certain price but finds a better price range, the previous one would not be of much significance.

2. Number of touches

Another indication of the strength of support is the number of touches. There are many traders who believe that the more times the price bounces back from an area, the stronger that price zone. But the reality is not quite so.

If an institution is accumulating a large position in a price area, after many times the price reaches this zone their position will be filled. When their position is sufficient, they will direct the market to their will. So when looking for support and resistance, you should look for areas with about 2 rejection, 4 or more times, you should avoid them.

3. Price volatility

Often a support resistance level is considered strong when they come after a strong rally or drop. This is because, after a sharp rise and fall, the price tends to bounce back.

4. Volume

The next factor we need to consider is volume. The volume provides us with information on price momentum, but there is another useful sign that higher volume means more quick selling, leading to potential resistance levels. more power.

5. Round number area

A lot of times you will see price move but end up staying around round numbers like 50 $,, 100 $, ... Actually, there is not much correlation between numbers and support resistance. It lies in the psychology behind these numbers.

Pivot Point

A pivot point is one of the typical technical indicators used to estimate future support resistance based on both past and present price action.

As shown below:




Resistance (R) and support (S) are respectively marked on the chart. And note, you should use frames D1 or above, the information that the pivot point provides will be more accurate.

Fibonacci regression

A pullback is a short-term correction in an up or down trend, it doesn't confirm a major trend reversal. The goal of this correction can help you enter a trade before the price returns to trend.

Fibonacci tools can help traders to identify the targets of these corrections. The figure below shows when we use Fibonacci to determine the price correction point:


As shown above, we see that the price is in an uptrend. Where a level from 61.8% to 65% is called the golden ratio on the Fibonacci. This price area is considered as a high possibility that the next price will reverse.

There are 3 ways that traders can apply supportive resistance to ineffective trading

First: Supportive resistance provides an entry point for reverse trading. If you analyze that at this support resistance there is a possibility of a reversal then that level will provide the trader with reliable entry signals to trade the reversal. As shown below:

Second: Use support resistance to trade the breakout. This is also how many traders use it. It is important to assess weak support resistance or a high chance of being broken by retesting multiple times. As shown below:


3rd: Use support resistance to place a stop loss. In case you are wrong, then the support resistance is an ideal area for you to place your stop loss. However, the strength and weakness of the supportive resistance, as well as the quality of the signal, greatly affect the quality of the stop loss.

What is the best time frame for support resistance?

Realistic support resistance appears on all timeframes. Supportive resistance levels closer to the current market price will be more valuable to the trader.

You should focus on finding support at or above the time frame you are trading. For example, if you trade H4 frame, you should identify the supportive resistance on D1 and above H4 to grasp strong resistances, to support your entry and exit.