How To Draw Support And Resistance Levels
The concept of support and resistance levels is one of the reasons for technical analysis.
It is impossible to trade the financial markets based on technical analysis strategies without knowing how to identify and draw support and resistance levels. It’s a skill every technical trader must acquire.
Despite the importance, there are many traders who don’t know how to identify the right levels.
Getting the support and resistance levels wrong will surely lead to bad trading decisions and poor results.
That is why, we’re creating this post to show you how to identify and draw the levels, the tools that help you predict potentially new levels, and how to use support and resistance levels in your trading.
Support and resistance levels are price levels where the market finds it difficult to go beyond.
In other words, when the market reaches those levels, the price is likely to reverse and head the opposite direction.
Basically, those levels were major turning points in the past, where the price started a new wave in the opposite direction.
They are like the floor and ceiling, where a bouncing ball hits and changes direction — the ceiling limits the upward movement, while the floor stops the downward movement. The ceiling represents a resistance level, while the floor represents a support level.
What is the support level?
A support level is a price level where a price decline was halted. That is, it is a level where the price stopped making a downward move and turned to head upwards.
The implication is that since the price couldn’t break below that level, there is a greater chance that the same thing will happen when the price gets to that level again, as can be seen in the chart below. Notice the number of times the price bounced off from that level
But why does a support level stop the price from continuing a downward move? The reason is simple — there are more buy orders at that level than there are sell orders.
Many of the buy orders come in the form of limit orders that both institutional and retail traders place there, with the hope that the price would reverse at that level.
There are also take profit orders for short trades taken at higher levels, as well as new buy orders (market orders) by traders who have been waiting for the price to get to that level to jump in.
Knowing that they would find enough liquidity at this level, institutional traders normally leave their buy orders in waiting at such levels.
Sometimes, they purposely push the price lower than the already established support level just to lure more sellers in to fill their buy orders.
As a rule, the support level lies below the current price level and may serve as the lower limit of a downward price wave, thereby becoming a floor (bounce off point) for the next upswing.
This holds true at all times — it doesn’t matter whether the price is in an uptrend, downtrend, or moving sideways (a ranging market).
However, the type of price wave that ends at a support level and, consequently, the nature of trade setups that forms there depends on the direction of the trend.
In an uptrend, pullback waves tend to reverse at support levels, and you may find trade setups in the direction of the trend.
But in a downtrend, it’s the impulse waves that end at support levels, so any setup that occurs there gives a counter-trend trade, and there’s a higher chance that the price will break below it to continue the trend.
Compare the chart below with the one above. Here, the support level stood in the way of the strong downward impulse waves and was eventually broken.
What is the resistance level?
The resistance level is a price level where an upward price swing stops, and the price turns downwards.
It is where an upswing gave way for a downswing to begin.
Since the price found it difficult to break above that level, it is highly likely that the price will reverse again if it gets to that level.
Take a look at the chart below. Notice how the price hit that level three times without breaching it
But what exactly makes the price turn downwards when it reaches a resistance level?
Well, the answer is that there is usually a huge number of sell orders at any significant resistance level.
Some of those sell orders are limit orders placed by traders, with the belief that the price would reverse at that level — a self-fulfilling prophecy.
There are also current sell orders (market orders) placed by traders who have been on the sidelines waiting for the price to get to that level so as to ride it down.
In addition, take profit orders for long positions entered at lower levels are also placed close to the resistance level.
The enormous liquidity found around resistance levels makes it very attractive for institutional traders who are looking to go short.
To fill their huge short orders, these big players sometimes push the price a little bit above the resistance zone to attract buyers so that they can fill their sell orders.
As a rule, the resistance level must be above the current price level so that it can serve as the upper limit of an upward price move and the turning point for the next downswing.
It doesn’t matter whether the price is in an uptrend, downtrend, or moving sideways (a ranging market), the resistance level must be above the price.
The type of trend — uptrend, downtrend or sideways — determines the odds of any trade setup that occurs around a resistance level.
In a down-trending market, you can find high-probability bearish setups around the resistance zone.
For an up-trending market, the resistance level stands in the way of the powerful upward impulse waves, so there is a higher chance that the price will break above it and continue climbing higher.
In a down-trending market, the price pulls back to the resistance levels and turns to resume the decline, so it’s safe to look for a bearish trade setup at such levels.
Take a look at the chart below and compare it with the one above. While in the first chart the level was resisting the advancement of a pullback in a downtrend, here, it couldn’t withstand the momentum of the second impulse wave.
Support-resistance polarity swap principle
The principle of support-resistance polarity swap implies that one level can become the other level when the price crosses it.
This means that if the price breaks above the resistance level, that level can then become a support level because it lies below the price at that moment.
Similarly, if the price breaks below a support level, that level, which then lies above the price, can become a resistance level.
It is more likely for the price to break the support level in a downtrend, because the downward waves (impulse waves), have stronger momentum and can take out all the buy orders at that level, triggering the sell stop and stop loss orders that lie below the level.
In the GBPUSD chart below, the market was in a downtrend — as indicated by the stronger downward impulse waves .
Notice how the support level stopped the first impulse wave from going lower, forcing the price to pull back to the resistance level .
The second impulse wave was able to take out the support level, and when the price pulled back again, later on, the previous support level resisted further upward move, thereby becoming a new resistance level.
A resistance level is more likely to be taken out in an uptrend where the upward waves are strong impulse waves that can take out all the sell orders at the resistance level and even trigger the stop loss and buy stop orders that lie above it.
For example, in the GBP USD chart below, the second impulse wave took out the resistance level, and when the price pulled back, it was stopped at the previous resistance level. So, that level has become a support level.
How to identify support and resistance levels
It is easy to identify previous support or resistance zones in the market, once you know that a resistance level must lie above the current price and a support level must lie below the price.
Since the market has memory and often remembers the previous resistance and support levels, those levels might continue to act the same way.
Two common ways to identify possible support and resistance levels in the market are
* Swing highs and lows
* Round numbers
Previous swing highs and lows
From our discussion so far, it’s clear that support and resistance levels are levels where one price wave ends and another begins.
So, it makes sense that previous swing highs and lows are considered support or resistance levels, depending on where they lie with reference to the current price.
However, for a price level to become a significant support or resistance level, the price must have hit that level and reversed on multiple occasions.
It doesn’t matter the direction of the price swings. Furthermore, it’s preferable to mark your support and resistance levels on a higher timeframe than the one you normally trade.
The levels on a higher timeframe are more important than the ones on a lower timeframe. Now, here’s how to draw your support and resistance levels.
Drawing a support level
Marking a support level may be a little different for the different types of trends.
To draw a support level in a ranging market, simply identify the lower boundary of the range — the zone where the downward swings end and turn to the upside — and draw a horizontal line joining as many swing lows as possible.
Note that the line mustn’t pass at the exact lows of the lowest price bars — it can cross through the tails or even bodies of the bars.
See the USD CAD chart below and notice how the line crosses all the four swing lows.
To mark the next support level in an uptrend, draw a horizontal line that crosses as many swing highs and lows as you can see on your immediate chart .
Sometimes, you may need to go a little far behind, but most times, what you can immediately see on your chart is enough.
In the USD CAD chart below, you can see the two potential support levels marked by lines. Each of the lies crosses previous swing highs and lows.
To draw a potential support level in a downtrend, you will need to go back to see when the market had traded below its current price and identify the important reversal levels.
In the example below,Notice how the price was sharply rejected below that level
Drawing a resistance level
To mark a resistance zone in a ranging market, identify the upper boundary of
the range— the zone where the upswings reverse — and draw a horizontal line
joining as many swing highs as possible.
See the USD CHF chart when the upper boundary of the range was added.
For the next possible resistance level in a downtrend, draw a horizontal line that crosses as many swing lows and highs as you can see on your immediate chart view.
Sometimes, you may need to go a little far behind, but most times, what you can immediately see on your chart is enough. See the AUDUSD chart below. Both levels represented by the red line.
To draw a potential resistance level in an uptrend, you will need to go back to see when the market had traded above its current price and identify the important reversal levels.
In some cases, you may not find any higher previous swing high because the price is currently at its highest level — here, tools like the Fibonacci expansion levels will help you predict potential resistance levels.
In the GBP CHF chart below, we can Notice the price rejection above the first level.
Round numbers
Aside from the swing highs and lows, other levels that can become possible price reversal levels are big round numbers.
The bigger (more number of zeros) the round number, the more important the level is. For example, 1.20000 is a more important round number than 1.25000.
When the round number is above the current price level, it can act as a resistance level when the price reaches there.
If the round number is below the current price level, it can act as a support level when the price reaches there.
See the GBPUSD chart below. Notice how the 1.7006 has been active price reversal levels, as indicated by the red arrows.
Other tools that indicate potential support and resistance levels
In addition to marking the previous swing highs and lows and important round numbers, there are tools that you can use to predict potential support or resistance levels in a trending market. They include the following:
* In addition to marking the previous swing highs and lows and important round numbers, there are tools that you can use to predict potential support or resistance levels in a trending market. They include the following:
* Fibonacci retracement and expansion tools
* Trend lines
* Long-period moving averages
Fibonacci retracement and expansion tools
The Fibonacci retracement tool is used to estimate the percentage of the preceding impulse wave which the corrective wave can retrace to before reversing.
Derived from the various ratios of the Fibonacci sequence, the most important retracement levels are 38.2%, 50%, and 61.8%, which normally act as support levels in an uptrend and resistance levels in a downtrend.
In an uptrend, attach the tool to the preceding impulse wave, from the low to the high, when a pullback starts.
Then look for whatever constitutes your trade setup when the price reaches the 38.2, 50, or 61.8 percent level, which can behave as a support level.
For a downtrend, you attach it from the high to the low of the preceding impulse wave and look for your setup at the significant levels which provide resistance.
In the GBP CHF charts below, the pullback for the previous impulse wave ended at the 50% retracement level, and the current impulse wave started.
The Fibonacci expansion tool is used to estimate the percentage of the previous impulse wave which the new impulse wave can expand to, from when the pullback reversed.
The expansion levels can be used to predict potential resistance levels in an uptrend or potential support levels in a downtrend, and traders use them to estimate their profit targets.
There are many expansion levels, but the 100%, 161%, and 261% are the most commonly used.
In a downtrend, you attach the tool from the high to the low of the preceding impulse wave and then drag the third limb up to the end of the pullback.
You then wait to see what price at the significant expansion levels.
For an uptrend, you attach it from the low to the high of the preceding impulse wave and then drag the third limb down to the end of the pullback, just like in the GBP CHF chart below.
Notice how the price was sharply rejected at the 61.8% expansion level.
Trend lines
Trend lines are not just used to delineate the direction of the trend. They also provide some support or resistance effects, depending on the direction of the trend.
For an uptrend, you attach a trend line across the lows of a series of rising price swing lows and extend it into the future.
So it can actually estimate the levels that can potentially act as support levels for each date in the future.
In the GBP CHF chart below, the white arrow points at the potential support level for the day.
In a downtrend, you attach the trend line across a series of declining swing highs, so it helps you estimate future potential resistance levels, as you can see in the AUDUSD chart below.
Long-period moving averages
In addition to showing the direction of the long-term trend, long-period moving averages can serve as dynamic support and resistance levels.
In an uptrend, the moving average stays below the current price and may provide some support when the price hits it.
You can see that with the 200-period simple moving average (SMA) in the GBP CHF chart below.
When the market is in a downtrend, the long-period moving average tends to stay above the current price and may provide some form of resistance when the price reaches it.
Take a look at the 200-period SMA in the GBP CHF chart below.
How to trade with support and resistance levels
The market is either trending or moving sideways, and in each of those market conditions, support and resistance levels can be very helpful in identifying high probability trade setups. However, you will have to approach the two conditions differently.
* Trading pullback reversals
* Trading breakout
Pullback reversal strategy
This strategy aims at entering the market when a pullback has exhausted its momentum, and a new impulse wave begins in the direction of the trend. The idea is to ride the impulse wave and hop out during pullbacks.
Support and resistance levels are very crucial when trading this strategy since they show potential price reversal levels for both the pullbacks (entry zone) and the impulse waves (profit targets).
The direction of the trend, however, determines where to look for potential trade setups and where to get out.
In an up-trending market, the impulse waves go up and possibly end at resistance levels, while pullbacks move down and reverse at support levels.
So, if you’re trading this strategy in an uptrend, you will have to look for a trade setup when a pullback reaches a known support level. Your trade setup can be a pin bar pattern or any pattern you like.
Take a look at the GBPUSD chart below. Notice the bullish pin bars at a support level
In a downtrend, the impulse waves move down and get stopped at support levels, while the pullbacks (rallies) go up and reverse at resistance levels.
Thus, look for your trade setups at known resistance levels. Take a look at the bearish pin bar pattern that occurred at a resistance level in the EURUSD chart below.
Breakout strategy
A breakout strategy in a trend tries to profit from the continuation of the trend after the price breaks above or below a known resistance or support level.
Traders who use this strategy believe that the price moves faster after a breakout. However, it’s more like joining a trade when the move has already started.
Pullback reversal traders would rather wait for the price to pull back to retest the broken level so that they can ride the next impulse wave.
When trading this strategy, your primary focus should be to find a breakout that happens with an impulse wave.
Such a setup carries a higher chance of success, unlike breakout that occurs with a corrective wave.
In other words, if the trend is up, look for a breakout above a resistance level, and if the trend is down, look for a breakout below a support level.
In the GBP USD chart below, you can see how the second impulse wave broke above the resistance level, providing an opportunity for breakout traders to jump in.
Notice that the price later retested that level, which then acted as a support level — a pullback reversal trader would’ve entered at this point.
The GBPUSD chart below shows a downtrend. Notice how the pullback tried to break above the resistance level but failed.
Later on, the next impulse wave broke below the support level, but the price made several pullbacks to that level before finally dropping.
Trading a ranging market
A ranging market is a market that moves sideways within a fixed range over a period of time, without significantly breaking out of the boundaries.
The upper and lower boundaries are the zones where the price reverses.
The lower boundary is the support zone, and you can mark it by drawing a horizontal line that connects two or more swing lows at that zone.
With the upper boundary being a resistance zone, you can identify it by drawing a horizontal line that connects two or more swing highs.
When the price reaches the support zone, look for whatever constitutes your bullish reversal trade setup —candlestick patterns or any other. Similarly, when the price is at the resistance zone, look for bearish reversal setups.
In the USDCHF chart below, you can see that three different candlestick patterns occurred at the boundaries of the range — two at the resistance zone and one at the support zone.
At the support zone, you can see the bullish pin bar, while the resistance zone has a bearish engulfing pattern, and an inside bar.
Trading any of these setups would’ve resulted in a good ride to the opposite end.
Knowing how to identify potential support and resistance levels is very crucial to your trading career because they make good levels for trade entry, stop loss, and profit targets.
Previous price swing highs and lows, as well as important round numbers, are some of the places the price may find support or resistance, but Fibonacci levels, trend lines, and moving averages also help to predict new support or resistance levels.