Support and resistance levels

In technical analysis, there are indicators that should be closely monitored. Among these indicators, the most important are surely the support and resistance levels. But it is still necessary to know how to spot these levels, to interpret them, and, more than anything, to know how to use them in trading and financial speculation.  

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Support and resistance levels

What are supports and resistances?

To understand the value of technical support and resistance, it is important to remember that markets react to the combined actions of buyers and sellers. It is the confrontation of buying and selling that establishes the price level, i.e. the price of the assets concerned.

  • Supports: A support is a sort of threshold from which the bullish movements slow down the fall in prices. This threshold is in fact considered by buyers as an interesting entry point to the market. It therefore generally indicates an upward recovery.
  • Resistances: A resistance is in fact the exact opposite of a support. It is therefore a threshold from which bearish movements slow down the rise in prices. This threshold is then considered as an interesting selling signal and therefore most often leads to a bearish correction.

 

How to interpret supports and resistances?

To interpret the support and resistance phenomena, it is advisable to draw a straight line connecting at least two or three points, which we will call a "support line" or "resistance line". Of course, the more points this line connects, the more reliable it is.

Furthermore, when a line is reached many times, it indicates a high probability of a break in that line.

Indeed, a support or resistance line does not guarantee a result in the sense of a price correction. Indeed, it happens that the capacity of buyers or sellers is compromised or that a particular market condition pushes asset prices to "break" this line, which then causes a continuation of the rise or fall towards a new support or resistance threshold.

 

Identify areas of support and resistance:

To identify support and resistance zones on a chart, it is important to understand that these thresholds most often correspond to a psychological phenomenon. They are therefore often round numbers or historical levels.

If the highest price reached in previous sessions is the same and has been spotted many times, it can be a valid resistance level, for example. Therefore, volumes should be used to determine the best supports and resistances.

 

Using support and resistance in trading:

Supports and resistances are essential elements of technical analysis. They can be used in this way:

  • Identified support can be used as a buy signal in anticipation of a rebound in the asset. It is also a good signal for short selling when it is broken. Of course, a break of support can also be a good selling signal.
  • Resistance can be interpreted and used in the opposite way. When the price of an asset approaches this threshold, it can be a good sell signal. But if the resistance is broken, it will be a buy signal.

Caution: While supports and resistances are good technical indicators for online trading, other phenomena involved such as trends or elements of fundamental analysis should be monitored.

 

Let's take a simple example:

On a Japanese candlestick chart of the EUR/USD for daily periods, we can see, as explained above, the two continuous horizontal lines at the top and bottom of the chart which give us precise indications of the support and resistance phenomena observed.

For a support is observed at 1.5360, so it is interesting to place for example a buy order at this level. On the other hand, a sell order can be placed at 1.6000, as this is the observed resistance.

The space between these two lines is called a "tunnel" or "channel" and the prices of the asset under observation will mostly oscillate within this channel.

 

How can I use this information to trade?

You will have understood that it is interesting for you to establish your sales and purchase strategy based mainly on the analysis of these two phenomena. However, you should not neglect other aspects and variable and non-cartesian phenomena such as psychological effects. It is therefore not advisable to base your entire strategy on these observations. These prices can indeed break supports as well as resistances. All it takes is a sudden change in the expectations of the main investors. The trend will then accelerate.

Logically, these major changes are triggered by a significant event in the news based on the economic calendar.

However, these dramatic changes can give you a valuable indication. Indeed, they are often synonymous with a bullish or bearish continuation depending on whether it is the resistance or the support that is broken.

This also explains why on some charts, prices can fall below support or above resistance in places. This is called a "break" of the trend because it is a "break" of the support or resistance.

We also notice that a breakout almost systematically leads to a new support as well as a new resistance whose level is thus reassessed according to the new market elements. We can even sometimes observe a reversal between the support and the trend, one becoming the other and vice versa, but this type of configuration remains rather rare.

Frequently Asked Questions

How to trade technical supports and resistances?

It is possible to trade technical supports and resistances by taking positions near these indicators. Indeed, we know that a major technical support can announce a continuation of the downward trend or a bullish reversal and that a technical resistance can lead to a continuation of the upward trend or a downward reversal. It is therefore necessary to wait and see how the price of the asset behaves when it reaches or approaches these levels.

How can I identify support or resistance graphically?

It is possible to visually identify support or technical resistance on charts. Support is represented by a low horizontal line, usually in red, while resistance is represented by a high horizontal line, usually in green. The middle line represents the pivot point and is often located equidistant from these two lines. Several support and resistance lines may be visible.

What other technical indicators should be used?

It is of course recommended not to use only technical support and resistance lines in your technical analysis. Indeed, by using several indicators simultaneously, you can increase the accuracy of your signals. Some of the most commonly used indicators in technical analysis are moving averages, MACD, pivot points, Stochastic and RSI.

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