How to Trade Support and Resistancesupport and resistance levels are crucial concepts that every trader needs to grasp. These levels represent key points on a chart where the price tends to reverse its direction. By analyzing historical price action, traders can identify these areas and strategize their trades based on how the price reacts upon reaching these levels.
The Simplicity and Complexity of S&R
While the idea of support and resistance is straightforward to understand, effectively trading these levels can be challenging due to psychological barriers and emotional involvement. Mastering support and resistance trading isn’t just about recognizing patterns; it’s also about understanding the human emotions driving those patterns.
What is Support and Resistance
Support is a price level where a currency’s downward trend is expected to pause due to a concentration of demand. It’s where buyers step in, viewing the currency as undervalued, thus preventing further price decline.
The OANDA:XAUUSD chart above depicts a notable support level of 2031. Historically, when the price of Gold reaches this level, it tends to initiate an upward trajectory. Traders can identify potential trading opportunities at this juncture and consider establishing long positions after the confirmation signal, such as a break of structure, signs of a liquidity sweep, or the order block.
Traders can also use the bullish candlestick pattern as an additional signal when considering support zones for buying opportunities.
In the FX:EURUSD pair, there is a noteworthy support zone extending from 1.0648 to 1.0666. Over several instances, the price has consistently demonstrated a pattern of bouncing upward from within this range, as illustrated in the chart.
Let’s see another example of support zones with stop-loss hinting.
The price level at 1.08924 serves as a significant support zone; however, it’s important to note that smart money often orchestrates moves that trigger stop-loss orders before driving the price upwards. Later in this S&R trading guide, we’ll delve into a detailed discussion of the concept of stop-loss hunting, complete with illustrative examples.
What is Resistance
Resistance levels are price levels at which the price tends to move in a downward direction.
Let’s analyze the chart provided above. The circled areas on the chart represent strong resistance zones where the price tends to move in a downward direction in the EURUSD pair. It’s worth noting that quite often, the price moves downward after triggering stop-loss orders in these areas. This phenomenon can be observed frequently in any currency pair.
The Psychology Behind These Levels
Fear and Greed: These are the two main emotions at play. At support levels, fear (of prices falling more) meets greed (for buying at a low price). At resistance levels, it’s the opposite; greed (for higher selling prices) meets fear (of prices dropping).
Group Thinking: Many traders are watching the same levels. When a lot of people act the same way (buying at support or selling at resistance), it reinforces these levels.
Self-Fulfilling Prophecy: Because so many traders are watching these levels, their reactions to them can make the support and resistance predictions come true.
Formula of Support and Resistance
Pivot Point Calculation
The Pivot Point (PP) is calculated as the average of the high, low, and close prices of the previous trading period:
Pivot Point (PP) = (High + Low + Close) / 3
First-Level Support and Resistance
First Resistance (R1) This is calculated by doubling the pivot point, then subtracting the low of the previous period.
First Resistance (R1) = (2 x PP) – Low
First Support (S1) This is found by doubling the pivot point and subtracting the previous period’s high.
First Support (S1) = (2 x PP) – High
Second-Level Support and Resistance
Second Resistance (R2) This level is calculated by adding the difference between the high and low of the previous period to the pivot point.
Second Resistance (R2) = PP + (High – Low)
Second Support (S2) This is determined by subtracting the difference between the high and low of the previous period from the pivot point.
Second Support (S2) = PP – (High – Low)
Third Level Support and Resistance
Third Resistance (R3) Calculated by adding twice the difference between the pivot point and the low to the high.
Third Resistance (R3) = High + 2(PP – Low)
Third Support (S3) Found by subtracting twice the difference between the high and the pivot point from the low.
Third Support (S3) = Low – 2(High – PP)
These pivot point-based support and resistance levels are crucial tools for traders, providing potential points of market reversal or continuation. The pivot point is often seen as a marker of equilibrium between bullish and bearish market forces.
The Phenomenon of Stop-Loss Triggers at These Points
A stop-loss order is a tool used in trading to sell a security when it reaches a predetermined price, to limit potential losses. To understand how it relates to support and resistance, consider the following analogy:
Think of trading as a game where you establish a rule: if your score drops below a certain point, you decide to exit the game to prevent further losses. This rule resembles the concept of a “stop-loss” in trading.
Now, picture a scenario involving seasoned players, often represented by large funds, who aim to maximize their gains in the game. They observe that many players have set their exit points at a specific level, such as 100 points.
These experienced players intentionally create the impression that the game’s score is approaching that critical 100-point level. As the score gets closer to 100 points, other players become anxious and decide to exit the game (activating their stop-loss orders) to avoid more significant losses. This sudden mass exit results in a sharp decline in the game’s score.
Smart money takes advantage of this situation by purchasing more points at the lower price they anticipated. After acquiring these points at a discounted rate, they allow the game’s score to rebound, ultimately profiting when it reaches higher levels.
In essence, this illustrates how Informed Money, often represented by large funds, may manipulate the market by creating the illusion that prices are nearing significant support or resistance levels. This can trigger the activation of stop-loss orders by other traders, enabling the seasoned players to capitalize on lower prices before the market resumes its upward trajectory.
Trading Strategy for Support and Resistance
When trading support and resistance make decisions on their base consider the following points.
Identify Support and Resistance in Larger Time Frames: Locate these levels in extended time frames like H1, H4, and D1 to gain a clear understanding of the market’s pivotal points. This approach not only clarifies your perspective when trading in smaller time frames but also reduces confusion. Confusion often arises from too many levels, making it challenging to determine which levels present viable trading opportunities.
Patience: Wait for the price to reach these levels and look for additional signals.
Utilize Bearish and Bullish Candlestick Patterns: Employing candlestick patterns at these levels aids in decision-making and enables traders to strategically set take-profit and stop-loss orders.
Develop a Trading Bias: Establish a daily bias at the beginning of each week to assist in deciding whether to take long or short trades. Focus only on those levels that align with your trading bias.
In conclusion, discipline is paramount in trading. It’s essential to avoid overtrading and adhere strictly to your established trading plans. Using stop-loss orders is crucial in managing risk and protecting your capital. Additionally, limiting your focus to a fixed set of currency pairs allows for a more in-depth understanding of their market dynamics, leading to more informed trading decisions. Remember, consistency and discipline in following these practices can significantly enhance your trading effectiveness and help in achieving long-term success.
how to identify strong support and resistance
Historical Price Levels: The most basic method is to look at historical price charts. Strong support and resistance levels are often at prices where the market has repeatedly reversed or consolidated. These levels are more significant if they have been tested multiple times.
Round Numbers: Psychological levels often play a crucial role in trading. Prices such as 1.3000 in EUR/USD or 100 in USD/JPY are examples where traders might expect support or resistance.
