Understanding support and resistance is fundamental to successful trading. A grasp on these two very simple concepts can allow traders to enter and exit trades confidently, seeking price areas where buying and selling will occur in enough quantity to resist price movements. The basis of this being the ‘memory’ that price has and which can be seen by looking to the left, rather than the right, of a price chart. Knowing what has happened before is essential to getting to finding areas of support and resistance and can provide traders with a definitive edge. Such is the power of this price action technique; many traders will use support and resistance alone to define their trading positions without reliance on any indicators or fundamental analysis.
Support and resistance form through the understanding of previous price action. Previous highs and lows form these key areas, representing where price has been rejected by the large majority of traders; they form psychological barriers where orders are placed in the knowledge that price may again be rejected in the future. The formation of a recent high or low thus shows traders a precise point where the market has struggled to move any higher or lower. Due to the tendency for trading to rely on what has gone before in order to establish the probability of a recurrence in the future, these highs and lows act as obvious marker points in creating a map of the future.
One of the most obvious examples of support and resistance in action occurs every day across many stocks, currencies and commodities. This can be seen through the existence of strong trends on any timeframe. When a market begins to trend to the upside it makes a series of rising waves. Each time the wave moves higher, before pulling back and making another higher wave. The pullbacks are also becoming higher, each time forming a higher low. This is the definition of a trend and the concept of support operates when these higher lows appear to ‘bounce’ of the top of the previous high. The market is therefore using the tops of the previous high as support to the price. Trader’s place orders at thee points in anticipation that price will not fall below these psychological levels. In regards to support this can be seen to operate conversely in a down-trend, where price hits an area of resistance based on the bottom its previous low.
Resistance is also very much in play when price reverses from each higher-high or lower-low. These are the areas where the market rejects the price pushing to higher or lower levels. Often these can define the end of the trend, when a high is made, price pulls back and the subsequent rally fails to rise above the previous high, creating a ‘double-top’ trading pattern and signifying the start of a significant consolidation in price. Traders often watch for price to confirm that it will rise above a previous high before entering a trade. This situation is a weighing up of the situation for traders, either price will reverse near to the previous high as the selling pressure (the resistance) is too strong, or it will break above before pulling back and use the new buying pressure (support) which has formed at the top of the previous high to move higher. This transition from resistance to support, and vice versa, is known in trading as ‘flipping’. Areas of previous strong resistance become areas of strong support once they have been broken.
Looking at the EUR/USD on a current daily chart, we can see that there is a clear, strong support and resistance line running around 1.3970. This has previously acted as strong support with price bouncing off during the earlier part of the year before switching to resistance on September 8th. Price retested this area on September 15th and was swiftly pushed back down. It is currently retesting this level, although today’s daily chart shows this resistance holding firm as confluence with the 62 EMA proves difficult to break through.