The levels called support and resistance are very useful lines on the price chart. They are of great help when determining the probability of the price breakouts and trend reversals. A lot of traders are relying on this tool. You should know what they are and how to use them properly.
The basics of the support and resistance levels
The support and resistance levels can be drawn on various chart types. I always recommend trading with the Japanese candlesticks. They are very transparent and most of the strategies are clearly visible. However, if you prefer other kinds of the price chart, you will still be able to use the support and resistance lines.
The lines of the support and resistance correspond to troughs and peaks formed by the price bars. They indicate significant points in which the traders should jump into action. The line which connects the lows is called the support and the one which joins the highs is the resistance. The bottoms and tops on the graph mirror the finance world law that is the supply of the seller and the demand of the buyer. The levels of support and resistance can guide the investors in their decisions about buying or selling. The price seems to respect the bottoms and tops that were previously formed.
There are two possibilities of how the price will behave after reaching the support or resistance level. It may either rebound or break through the line. And the trader should act accordingly.
Price rebounds from the support or resistance levels
The price forms the troughs and peaks all the time. When we have the support or resistance drawn on the chart, we can forecast how far the price will go the next time. It is quite possible it will rebound from the same level as it did before. Like this, a channel is created in which the price is moving up and down.
Such rebounds create opportunities to open the trading positions. When the price comes to the lower boundary, it gives a signal to buy. A position can last as long as the price nears the upper line. And in case the price goes up to the resistance level, it is time to sell. The position should be closed as soon as the price reaches the lower line.
Trend lines as the support/resistance
The trend lines are the inclined lines that are showing the direction of the trend. The local lows are a base for the trend line during the uptrend and the local highs are used during the downtrend. However, the trend lines not only indicates the price direction but can also be used as dynamic support or resistance levels.
To supplement the trend lines you can include horizontal support and resistance levels. Such a move can help you to develop a trading strategy.
Price breakouts from the support and resistance levels
The support and resistance levels are forming the limits within which the price is bouncing for a while. But eventually, the price will break through them. It may be viewed as the announcement of a strong trend and good trading opportunities at the same time. Nevertheless, it is a bit more difficult to trade based on the breakouts. It requires that the trader watches the price chart carefully for a very long time not to overlook his chance.
There are traders who prefer to wait until the price retraces and then enter the trade. The retracements happen when the price breaks out from the support or resistance levels, but after that, it changes the direction and comes to the support/resistance from the other side. This is, however, a short move, and it is right back on the track. This is considered to be a good entry signal for many investors.
Is it a true breakout or just a fakeout?
Sometimes, the market does not behave as expected. With the support/resistance levels drawn and the price reaching the lines and crossing them on its way down or up, we would anticipate the breakout. And most often this is exactly what will happen. But on some occasions, the price will go back instead of continuing the former direction. This is what we called the fakeout.
The best method to find out whether it is a breakout or a fakeout is to conduct a deep analysis of the market. Watch a candle that follows the breakout. When it is formed in the opposite direction, you may be expecting the fakeout.
This is the reason why many of the traders would rather wait for the retracement of the price to enter the position than to rush into the trade as soon as the price breaks through the support/resistance.
The support and resistance levels are based on mass psychology. The previous behaviour of the price during a specific time is analysed and the conclusions are drawn. Similar movements are expected to occur. The price is likely to fall into the same range.
The support and resistance levels are the technical analysis tool that is worth to know. It cannot guarantee success, but it can take you a little bit closer to it. Use it wisely. Always check with the economic calendar if there are some news releases announced. They may interfere with the situation on the market and it is better to avoid trading in such moments.
On many platforms, you will find a special feature that is called a demo or a practice account. It is usually free of charge and credited with virtual cash. Use it to introduce new strategies. Check how the support and resistance levels work.
Best of luck!