How To Leverage The Support And Resistance Trading Strategy
The concept of support and resistance levels is crucial for most technical trading strategies. It’s one of the oldest and most highly discussed tools in technical analysis. With support and resistance, traders can more accurately identify areas where the price of an asset will likely reverse and analyze chart patterns.
Some of the top traders who rely on technical analysis tools like support and resistance can make six or seven figures in a single transaction! George Soros, one of the best traders in the world, is nicknamed “the name who bankrupted the Bank of England” and once made $1,000,000 from a single transaction.
While the idea behind these levels is relatively simple, they can take quite some effort to master. That’s why we’ll provide an extensive guide of support and resistance so you can learn:
* What support and resistance levels are
* How they work in practice
* How to identify them
* Why they are useful
* How to draw them
* Common indicators to look out for
* Tips and tricks
Key Takeaways
* Support and resistance levels get used to identify areas or zones on a chart where the price action is likely to reverse or pause based on an previous trend.
* To find a good support level for a security, identity an area where a downtrend is expected to reverse or pause due to buyer pressure.
* To find a resistance level for a security, identify an area where an uptrend is expected to reverse or pause due to selling pressure.
* Commonly used indicators and techniques to identify support and resistance levels include Fibonacci retracement levels, trendlines, and moving averages.
What are Support and Resistance Levels?
Example of Support and Resistance for Enphase | WebullTo visualize support and resistance levels, think of support as a metaphorical floor and resistance as a ceiling. In our Enphase example above, you can see a clear pattern where the price does not go above ~$188.23 (resistance) or below ~$185.43 (support) for some time.
When you look at a price chart, thesupport levelis an area where there is potential buying pressure, or a concentration of demand, which can prevent a security’s price from falling below a certain level. In other words, at the support level, buyers are more likely to jump in and push the price back up, thus causing the market to reverse course. The buying pressure could be from anyone, such as financial institutions, banks, smart money, or retail investors.
Theresistance levelis an area where there is potential selling pressure, or a concentration of supply, which can prevent a security’s price from rising above a certain level. In other words, at the resistance levels, sellers are more likely to push the price down and reverse the market’s upward trend.
While support and resistance typically are represented as horizontal lines, think of them as areas or zones that can break and get pushed around instead. If they were specific price points that remained stagnant over time, any trader would be able to time their entry or exit points there. With that said, once you identify these areas, you can use them as potential entry or exit points.
As the price reaches this area, it will do one of two things. It will either reverse course or continue in its direction to set a new support or resistance level. In our Enphase example, we see its price reverse course whenever it hits the support or resistance levels we drew. However, later on, we see the price continue to fall below the current support to set a potentially new support level.
Traders typically make trading decisions based on the belief that these zones will not break. However,the more times they get tested, the weaker they become. If we take another look at the example above, we can see that the price breaks through the support level after getting tested several times.
How to Identify Support and Resistance Levels
Example of Support and Resistance for Tesla | WebullTechnical analysts and traders use various technical indicators, such as moving averages or trendlines, to identify support and resistance levels on a chart. The idea is that price action will typically react according to these designated areas. To identify these zones more accurately, we recommend taking a deeper dive into technical analysis, which is a style of trading that relies heavily on charts and patterns.
A common way of determining these zones would be to identify points where the price usually slows down or stops. Sometimes, these levels may result from psychological barriers as many beginner investors and traders prefer setting entry or exit points at round numbers. In the Tesla example above, we see that $700 is a potential psychological barrier for many traders as the price can’t move past it.
Why Are Support and Resistance Levels Useful?
Understanding how support and resistance areas work plays a significant role in an active trader’s probability of success and profit. For example, if you day trade or scalp, accurately and quickly identifying zones of support and resistance could make or break your trading strategy.
If you randomly take a position without any research beforehand, you risk losing a lot of money. If you want to take advantage of a stock’s upward momentum, for example, buying a position at the peak could cause you to end up bagholding losses if the price crashes back down as quickly as it went up.
How to Draw Support and Resistance Lines
Before you draw support and resistance zones on your charts, choose a timeframe that works best for you. Your timeframe can range from one minute to one day depending on how your trading strategies look. The higher the timeframe, the easier it becomes to identify key reversal levels and critical points. The shorter the timeframe, the more you need to stay focused because your zones are likely to get hit more frequently.
After picking the timeframe, draw horizontal lines on any recent peaks and bottoms in your chart. In our example below, we chose a 30-minute timeframe for Beyond Meat and identified an area of support and resistance. As we mentioned earlier, the more these zones are tested, the more likely they will break down. You can see that after the support level gets tested several times, the price breaks down and falls to a new low, with the previous support level temporarily acting as a resistance level. Meanwhile, a new support level gets established at a lower price point.
When drawing these lines, make sure to have multiple touches as that indicates the price action stood the test of time and remained at those support and resistance zones. As we like to say, history often repeats itself, whether you deal with stocks, cryptocurrencies, forex, or another financial market.
Example of Beyond Meat | WebullNote that we try to limit ourselves from drawing too many lines on our charts and keeping some space between them. When you draw too many zones close together, that can become confusing and lead to poor trading decisions. Leave enough space between lines to focus on the quality of your zones rather than the quantity.
Support and Resistance Indicators
There are a few technical indicators and techniques you can use to find support and resistance levels successfully.
Fibonacci Retracement Levels
Fibonacci retracement is a popular tool among short-term traders. It identifies clear levels of support and resistance using horizontal lines. Based on Fibonacci numbers, each level is associated with a percentage that indicates how much the price has pulled back, or reversed, from a prior move. The official levels are 23.6%, 38.2%, 61.8%, and 78.6%, though 50% is also commonly used.
In our visual representation of Fibonacci retracement below of Beyond Meat, you can see the horizontal lines drawn for each level. You will notice several downward trends between 61.8% and 23.6%, which represents the price correcting. It also reinforces the idea that human behavior tends to follow a sequence.
Fibonacci Retracement for Beyond Meat | WebullYou can use this indicator to identify entry orders, determine stop-loss levels, or set specific price targets. They can be effective in the long term to identify dips as entry points. Taking another look at the Beyond Meat example above, if you see the stock fall to around $121, which is where the 23.5% Fibonacci number is, that may be a good buying opportunity. We can see that the price generally will not fall below his level. If you are waiting for the right opportunity to buy the stock at a lower price, this may be a good entry point.
While the Fibonacci levels are good signals for identifying or confirming areas to stay alert for trading opportunities, there is no guarantee that the price will reverse at any particular level. They provide an estimated turning point, but the price doesn’t always stop at that specific point. Additionally, if they get used on small price movements, they may fail to provide enough insight. That is because the levels might appear too close together to identify which price level is more important.
If too many Fibonacci retracement levels get used, the price will likely reverse near one of them pretty often. Like drawing too many support and resistance levels, using too many Fibonacci levels makes it harder for traders to figure out which one is most useful.
Trendlines
In our previous examples, we used static barriers to show support and resistance levels. However, the prices of most financial securities generally trend upward or downward, which is why you can also identify them using trendlines, or price barriers that change over time. Trendlines are visually represented as diagonal lines on your charts, indicating that support and resistance levels can be dynamic. As a general rule of thumb, a trendline should connect at least two significant dots.
In our example above, we see that the stock is trending upwards with ascending peaks and reaching higher lows each day. When the market trends to the upside, resistance levels get formed as the price action of the market moves toward the trendline. This behavior typically results from traders taking profits or feeling uncertain, which leads to a “plateau” effect or a slight fall in the stock price.
Traders often pay close attention when the price falls towards the upward trendline identified because this area will likely prevent the price of a security from falling below it. Depending on the type of security, this trendline can act as a support for months or years. In the Snowflake example, we see that the trendline propped up the price of its shares for several weeks.
Example of Downward Trendline for Roblox | WebullOn the other hand, if the price of a security is trending downwards, traders will look for declining peaks and try to connect them with a trendline that hits lower lows each day. In our example with Roblox using a 15-minute timeframe, we can see that the price continues to fall near the trendline throughout June. When the price approaches the trendline, in this case, traders will look for any selling pressure and potentially enter a short position around this area because the price keeps getting pushed down.
Moving Averages
Moving averages (MAs) are one of the most commonly used technical indicators to identify support and resistance. MAs act as dynamic support by calculating the average price of securities over a specified time, such as 100 days or 200 days. It gets represented by a line that constantly changes and smooths out historical price data. Two popular types of moving averages include the simple moving average (SMA) and the exponential moving average (EMA).
Example of Moving Averages for Nvidia | WebullTraders tend to use indicators like moving averages to predict short-term momentum, as they create “automatic” levels of support and resistance. In the Nvidia chart, we can see the importance of using moving averages. As you can see, the 100-day and 200-day moving averages help the buyers control the uptrend as multiple attempts to reach lower lows get capped by the two MAs. When the trend of a security is up, its price finds support at the moving average. However, when the trend is down, its price finds resistance at the moving average.
Generally, traders will experiment with different moving averages to find one that works best with their trading strategy. Note that MAs rely on historical data, so always use them in conjunction with other technical indicators.
Tips and Tricks
1. Don’t put your stop loss at the support and resistance levels.
If you’ve identified solid support and resistance levels, chances are, so have other traders. If you set yourstop lossat these exact levels, it’s easy for it to get hunted and push you out of a trade prematurely. While there is no way to avoid this situation entirely, there are a couple of things you can do.
Rather than setting your stop loss precisely at these levels, set it at a safe distance away and wait for thecandlesticksto close beyond them. To find the right spot to put your stop loss, you can use theaverage true range(ATR) indicator, which measures market volatility. Then, only exit your position if the price closes below the low of your support level or the high of your resistance level.
2. Avoid getting trapped by identifying when support or resistance will break.
Support tends to break when the market is trending downwards, while resistance tends to break when the market is trending upwards. Additionally, both support and resistance levels tend to break when there’s a buildup.
For a downtrend to keep going, the price has to keep reaching lower lows. That’s why going short at the resistance level is a better idea than going long at support in this instance. For an uptrend to continue, the price has to keep reaching higher highs. That’s why it’s better to have a long position at the support level rather than shorting at the resistance.
Example of Support Level for Nvidia Breaking Down | WebullWhen there’s a buildup, support and resistance will get tested many times, which weakens them. For example, let’s say there is an area with potential buying pressure, but the price consolidates at the support zone instead of moving up. That could be an indicator of strong selling pressure or weak buying pressure, both of which make it more likely for the support to break down.
3. Traders are human and can make mistakes.
In the perfect world, everyone would act rationally and make the best decisions. However, as humans, we are often are swayed by emotions such as greed, fear, anxiety, or excitement. Thus, we will make mistakes over time, whether it’s heuristics, cognitive errors, expectation errors, etc. Both trader (individual impact) and market (broad impact) psychology are powerful forces that impact price action.
There have been many times where I held onto a position too long out of greed and ended up losing upwards of 50% of my initial investment. Other times, I saw returns upwards of 200% on a single stock. Part of being a successful trader or investor requires learning how to control your emotions and taking a disciplined approach to whatever strategies you use.
4. Trading is a zero-sum game.
For the most part, trading is a zero-sum game, meaning that when you profit from a trade, someone else on the other side will lose, and vice versa. That’s why managing your risk is very important. If you overleverage your positions, you could end up losing a significant amount of money.
With any investment, only put in money that you are willing to lose or do not need anytime soon. No matter how confident we are about our trades, there will be times when we lose and times when we win.
Final Thoughts
Support and resistance levels are commonly used by technical analysts and are the foundation of various technical analysis tools. When used masterfully, they give traders a relatively accurate picture of what price levels to pay attention to to find entry and exit positions, manage risks, place stop losses, and more.
To get started with using support and resistance, play around with the tools available from whatever investing platforms you are currently using. In the examples I showed above, I was using Webull to draw support and resistance levels, trendlines, Fibonacci retracement levels, etc., for the different stocks. However, there are many other platforms you can check out depending on the types of securities you want to trade.
We are not financial advisors. The content on this website and our YouTube videos are for educational purposes only and merely cite our own personal opinions. In order to make the best financial decision that suits your own needs, you must conduct your own research and seek the advice of a licensed financial advisor if necessary. Know that all investments involve some form of risk and there is no guarantee that you will be successful in making, saving, or investing money; nor is there any guarantee that you won’t experience any loss when investing. Always remember to make smart decisions and do your own research!