Support and Resistance: What is it and how I use it.
There is nothing magical about support and resistance levels. They are points on a chart where either buyers took control from sellers(support) or sellers took control from buyers(resistance).
The ability to trade support and resistance is an art, there is no secret or formula that will give you an edge. It takes good judgment and good judgment comes from experience and experience comes from bad judgment. Learning these things take time.
The point of any analysis of public equities is to get on the right side of the order flow for the time frame you are investing.
In this lesson, I will cover:
- Pivot points
- How to determine reward/risk
Support and resistance are two of the most common terms in technical analysis. They both describe levels where price has a tendency to find buyers(support) and sellers(resistance).
As the above chart shows, price found support ahead of the 1.35 level. The reason for this is simple. The demand at that level was greater than the supply.
It makes sense when you think about it from the traders perspective. If you were short this cross, you are naturally looking for places to take profits. The 2015 low(left blue arrow) is a logical place to do that.
If you were looking to get long, the 2015 low is a logical place to start looking for long positions.
Since testing the 2015 low, this cross has rallied about 825 pips. We now have two data points on our chart where it was proven that the sellers lost control to the buyers. The first is the 2015 low(left blue arrow), the next is the February 2017 low(right blue arrow).
These two points are obvious and they will be used in the future as reference points for both longs and shorts.
Note: This is a weekly chart. In my experience, the support and resistance levels on longer time frames(weekly, monthly) carry more weight than 5 minute, hourly, or daily time frames.
Let's look at a few more examples of support:
As I note on the chart(blue arrows), support is not one specific price point, like 95, but a range of price levels, 90-95.
A trend line is another type of support level. The only d/f is that the support level is rising instead of horizontal(see chart above).
As the above chart shows, price found support at the 0.7600 level on 4 separate occasions, meaning the sellers could not maintain control below the 76 level.
Eventually, the buyers could not maintain control at the 76 level and gave up, adding to selling pressure and causing the 76 support level to break.
You can play around with the chart below. Try drawing support lines. The more you practice, the better you will get at it. (Works best on desktop)
Click "make it live" in the top right corner. Once the full chart is up, look on the left edge of the screen and click the little > icon.
The toolbar will appear. Click the trendline drawing tool to draw support and resistance lines.
Resistance works off the same principals as support levels. It refers to a level(s) on a chart where sellers take control from buyers.
Note: Many traders attempt to buy breakouts. Breakouts occur when price "breaks out" above a certain level. See below.
Like trendline support. Resistance can be in the form of a trendline. See below.
The trend line held on two separate tests. I say two and not four because you need 2 points to draw a line in the first place. If price would have continued higher up through the trendline, it would have ceased to be a useful point of reference.
Play around with the chart below. Practice drawing resistance and trendlines.
Pivot points are levels that were once resistance and then turned into support or were once support and then turned into resistance. See the chart below.
Let's bring all of it together. See chart below
The chart above is an example of support and resistance levels, trend lines, and pivot points all working together to give you a good picture of where the order flow might change.
Like I have mentioned previously, there is nothing magic about these levels, but every trader using technical analysis will be aware of them and will look to trade against them.
There is no point in trading if the reward/risk is not attractive. Risk/reward is more common, but when doing the math, reward/risk is easier to work with, IMO.
Before doing this calculation you need to determine two points.
1. Where you are putting your stop. This is a hard number. If you are trading forex or futures, I always recommend using a hard stop, not a mental one.
2. Your target where you will consider taking profits or moving your stop to break even.
Note: When calculating reward/risk, you are making an educated guess based on your judgment and experience. Every trade you put on will have an uncertain outcome. There are no "sure things". Remember that.
In other words, it is not so much what you think, but what are other traders thinking, what are they seeing, what will cause them to give up their position. You need to think through all these questions and try to put yourself in their shoes because it is their orders that will push your position to either a profit or loss.
These things take experience and making mistakes over and over until you learn to execute without hesitation. You have to get comfortable not knowing how a particular trade will turn out. You have to willing to give back profits if, through your analysis, you see a much bigger move.
IMO-The big money is made in the big moves, not day trading.
This why trading is an art, there is no formula, only a trader's personal judgment, based on his/her experience and discipline.
Sorry for the rant, now let's get back to it....
Let's look at an example.
I am putting the words in the chart above, below
Lets's say you took a short position off the daily chart at the close(yellow square).
Your stop is going to be 10 pips above the high for that day.
That day closed at 1.3559. The high for that day was 1.3598.
Your stop would be 1.3608. 1.3598 + .0010 = 1.3608. Your risk would be 49 pips: 1.3608-1.3559 = .0049 or 49.
Your target is the 1.30 level. I picked that level because it has been "proven" that price has had tough time breaking below it. That is 559 pips. 1.3559-1.31 = .0559 or 559.
So your reward/risk would be your "potential"
reward of 559 divided by your "known" risk of 49: 559/49 = 11.41
If you risked $100 dollars, you would make $1,141 if you took profit at your target level of 1.30. $100 * 11.41 = $1,141.
Note: Just because you pick these levels does not mean that price will get to them. Price could stop half way or a quarter of the way to your target, reverse and stop you out. That is why it is important to write down why you took the trade, where you will take profit, and where you will get out.
The reason for this is simple. Something will come along that will make you question your logic on why you took that trade. Having a plan and sticking to it is the only defense against the noise that you will be exposed to on a daily basis.
Experienced traders, myself included, are not exempt from making these mental errors. I occasionally take profits too early when I planed on holding it.
It's hard. That is where experience comes in. I have found the pain of not being in a big winner, because I took profits too early, is far worse than losing a small percentage of your account.
I hope this lesson has been helpful. I am putting a form at the bottom of this page. If you are confused by something I wrote, have further questions, or spotted an error, please fill it out and let me know. I want this content to be valuable to the reader:)