Support
Support is the level at which demand is strong enough to stop the stock from falling any further. In the image above you can see that each time the price reaches the support level, it has difficulty penetrating that level. The rationale is that as the price drops and approaches support, buyers (demand) become more inclined to buy and sellers (supply) become less willing to sell.
Resistance
Resistance is the level at which supply is strong enough to stop the stock from moving higher. In the image above you can see that each time the price reaches the resistance level, it has a hard time moving higher. The rationale is that as the price rises and approaches resistance, sellers (supply) become more inclined to sell and buyers (demand) become less willing to buy.
- Technical analysts use support and resistance levels to identify price points on a chart where the probabilities favor a pause or reversal of a prevailing trend.
- Support occurs where a downtrend is expected to pause due to a concentration of demand.
- Resistance occurs where an uptrend is expected to pause temporarily, due to a concentration of supply.
- Market psychology plays a major role as traders and investors remember the past and react to changing conditions to anticipate future market movement.
- Support and resistance areas can be identified on charts using trendlines and moving averages.
This is how support and resistance are normally traded:
Trade the “Bounce”
- Buy when the price falls towards support.
- Sell when the price rises towards resistance.
Trade the “Break”
- Buy when the price breaks up through resistance.
- Sell when the price breaks down through support.
Plotting Support and Resistance Levels
With candlestick charts, these “tests” of support and resistance are usually represented by the candlestick shadows.
Notice how the shadows of the candles tested the 1973 support level.
At those times it seemed like the price was “breaking” support.
In hindsight, we can see that the price was merely testing that level.
One way to help you find these zones is to plot support and resistance on a line chart rather than a candlestick chart.
The reason is that line charts only show you the closing price while candlesticks add extreme highs and lows to the picture.
These highs and lows can be misleading because oftentimes they are just the “knee-jerk” reactions of the market.
When plotting support and resistance, you don’t want the reflexes of the market. You only want to plot its intentional movements.
Looking at the line chart, you want to plot your support and resistance lines around areas where you can see the price forming several peaks or valleys.
Other interesting tidbits about support and resistance:
- When the price passes through resistance, that resistance could potentially become support.
- The more often price tests a level of resistance or support without breaking it, the stronger the area of resistance or support is.
- When a support or resistance level breaks, the strength of the follow-through move depends on how strongly the broken support or resistance had been holding.
With a little practice, you’ll be able to spot potential forex support and resistance areas easily.
Conclusion
Technical analysis is one approach of attempting to determine the future price of a security or market. Some investors may use fundamental analysis and technical analysis together; they’ll use fundamental analysis to determine what to buy and technical analysis to determine when to buy.
Don’t forget that technical analysis is not an exact science and it is subject to interpretation. If you continue your study of technical analysis, you’ll likely hear someone say it is more of an art than a science. As with any discipline, it takes work and dedication to become adept at it.
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