Trading using Support and Resistance levels
One of the most widely used technical indicators in trading is support and resistance levels, which may be a highly effective method for forecasting price behavior. There are areas of price congestion which can help traders make decisions based on better than average probabilities and to identify buying or selling opportunities.
What are support and resistance levels?
Support is the price level where the probability is high that it may act as a floor by preventing the price from being pushed downward. The ability to identify a support level is very important in trading as it can help the investor identify a good buying opportunity. The logic behind this is that when a price has fallen to a level where demand at that price increases and buyers begin to buy, this creates a floor, or else a support level. Similarly, a resistance level is the level where it may act as a ceiling by preventing prices from rising further, which can help traders indentify good selling opportunities. This is because when a currency pair rises to a price where demand decreases, buyers begin to sell to lock in their profits creating a resistance level.
Identifying and using support and resistance levels
Support and resistance levels can be easily identified by studying the chart. To find a support level, search for low points in the chart where a currency pair falls to but then falls no further. To identify a resistance level, search for high points where the currency pair rose to but then retreated. If you are a long trader, you may think to set a stop level slightly below the support level. The reason is that you know it is likely that prices will rise once they hit support. If the support level is broken then your stop automatically closes your position and protects you from a potential powerful price drop.
The most important to identify and distinguish are strong and weak levels. Some levels are much stronger than others which may offer a higher chance for success. The key to identify strong and weak support and resistance levels is time. Higher time frames can reveal stronger levels with a higher significance and a higher probability of success. But higher time frames may hide some weaker levels and, hence, potential trades and gains. Weaker levels are mostly used to define exact entry points and management purposes rather than originating a support and resistance level.
Strong vs weak levels
What is very important to understand its whether a level has a historical significance. Did this level act as a support or resistance at least two or three times when looking at a higher time frame? If yes then you are looking at levels with high significance. If the level is identified at a short time frame then the probability this can act again as a level is lower. If a level was created at a 15 minute chart, and then price makes a run back to it, it is wiser that you be hesitant about putting a new trade. A level that sits for a longer period of time may be considered to have a higher significance as it has a higher probability that it can act as a support or resistance level again.
Another way to identify strong and weak levels is by taking into consideration the Fibonacci levels 0.2360, 0.382, 0.50, 0.618 and 0.764. If the Fibonacci levels coincide with significant support or resistance levels then this adds more weigh and significance to these levels. Investors will expect that prices will hit or surpass these levels.
Diagonal trend lines are also used in order to understand whether a support or resistance level is holding a significant weight. If a diagonal trend line is in conjunction with horizontal support or resistance levels then the levels offer a very high probability.
Understanding the concept of support and resistance levels may be valuable to all traders but like many things in life support and resistance levels are not always true. Some say that the success of the support and resistance may create a self fulfilling prophecy. When used by a vast number of traders, these levels themselves may become a major factor in influencing the market as the collective whole sees those levels and act based on them. It may be wiser to combine support and resistance levels with other technical indicators, which will offer more confidence to your trading strategies and help you identify strong and weak levels.