How to Use Support and Resistance Levels in Trading
Knowing how to use support and resistance is fundamental to reading a price chart. In fact, they’re one of the most commonly used indicators in Technical Analysis.
Together, they show the strength of a stock’s movement upward or downward. This allows technical analysts to establish a pattern and identify optimal entry and exit points. Those points are price floors and price ceilings.
When viewing a chart, the price will bounce between them. This creates an identifiable channel of price action. With support and resistance trading, traders find opportunities where they can buy close to the price floor (support) and sell close to the price ceiling (resistance).
What Are Support and Resistance Levels in Trading?
Support and resistance levels are the horizontal lines that traders identify on price charts. At a certain share price, a stock may bounce several times off these lines. The one below price action is support, the one above it is resistance.
As mentioned, traders pay attention to them because they establish clear price floors and ceilings. They can tell traders where a move downward may reverse, or a move upward may come back down.
Support and resistance in trading is based on market psychology. Support is where demand is at its highest, so buyers step in. Resistance is where supply takes the lead, so sellers exit there. This creates repeated price reactions at resistance and support levels.
Price can and does break through support and resistance. When that happens, the previous support becomes new resistance (if moving downward), or the previous resistance becomes new support (if moving upward). Knowledge of candlestick patterns can further help traders determine price action.
How Traders Identify Support and Resistance Zones
Support resistance trading is all about identifying those zones on a chart. The chart turns those psychological buying/selling levels into a quantified, visualised barrier that the price bounces away from.
Here are some common methods traders use to find them:
- Historical highs and lows determine a stock’s long-term resistance and support levels.
- Within shorter-term price action, swing points also show how price moves up and down, making V formations that show local support and resistance.
- If those swing points happen at the same levels, consistently, then it proves support/resistance zones.
Zones often crowd at round numbers ending in 0(s). This is because, as established, the chart is a representation of all traders’ psychology. When trading support and resistance, many place buy and sell orders at the closest round number.
Note that support and resistance are zones, not anchors to a specific price point. Traders may identify support at £10, for example, but it’s possible for the price to hit £9.50 or £10.20 before support kicks in. The same is true for resistance.
As the price moves, expect support and resistance levels to move with it. Traders get dynamic support and resistance levels from moving averages in short-term (20-period) to long-term (200-period).
Support and Resistance Trading Strategies for Planning Trades
Identifying support and resistance allows traders to find ideal entry and exit points, then plan their trade around them. They’re crucial for two kinds of trades – bounce trades and breakout trades.
Bounce trades try to profit from the movement between support and resistance. Traders would look to buy near support, preferably just above it after a confirmed bounce. If it’s a short-term trade, they’d look to sell close to resistance, preferably under it to beat the other sellers.
Smart risk management dictates that the trader places a stop loss just below support, in case it fails. Likewise, they may use an automatic take-profit order to sell. Entering at support allows the use of a tight stop loss combined with a clearly defined profit target near resistance.
Breakout trades target instances where the resistance has failed, meaning share price moves through an established ceiling. When this happens, it shows momentum is forceful enough to break that psychological sell-at-resistance pattern observed previously.
On seeing such a breakout, a trader would try to enter just above the old resistance. They would then place a stop loss back inside the ceiling. This is because a breakout can be false, and price can return to established support and resistance levels.
As for a breakout trader’s profit target, they’d zoom out to get a look at the next resistance zone. Then, as with bounce trades, they’d put a take-profit below it. Traders can gauge the potential strength of a breakout by looking at trading volume.
Trading support and resistance is all about finding the best zones to buy and sell, while making use of tools like stop losses to mitigate risk. By doing this, traders can get better risk-reward ratios than in less informed trades. Knowledge of resistance and support trading factors into most educated traders’ trading plan.
Using a Support and Resistance Indicator Alongside Price Action
To frame their trade, some traders rely on indicators that highlight support and resistance levels. As with all indicators, they add structure to a trade but cannot predict where price action actually heads.
As mentioned, volume is a reliable indicator of whether a bounce or a breakout setup is occurring. Bounces see low, unremarkable volume. Breakouts see a surge in volume. If price action breaks out on low volume, it may well be a false breakout.
Similarly, moving averages capture historic price movement in a simple, meandering line. Traders look at Simple Moving Averages (SMA) and Exponential Moving Averages (EMA). Since many traders watch them, and base their trades on how these lines move, they become a strong support resistance indicator.
Pivot points are another predictive indicator traders use. Traders take the last trade session’s high, low and close. Using those, traders can pull seven levels up on the chart. Three support levels, three resistance levels and the central pivot point between them.
If price opens above that central point, traders expect bullish action. If below, bearish. The first support and resistance levels (S1 and R1) are the most common targets. It is uncommon for the price to stretch to S3 or R3 and, if it does, traders expect a reversal to the central pivot point.
Lastly, the Fibonacci indicator identifies similar levels from swinging price action. Drawn from the swing low to the swing high, it shows levels at 23.6%, 38.2% and 61.8%. Traders then watch to see if price action bounces off them. If price drops through all three levels, the trend is no longer active.
Traders should understand all the tools and indicators at their disposal before trading. That’s why we at ActivTrades offer a demo account that allows risk-free paper trading. There, prospective traders can test their skill and see trading tips in action.
Support and Resistance Trading FAQs for Beginners
What is the Best Timeframe to Trade Support and Resistance?
There is no ideal timeframe in resistance and support trading. The best is whatever suits your trading style e.g., day trader versus longer-term investor.
No matter how you trade, zooming out can give valuable context into how the stock behaves and macro support and resistance behaviour. Generally, the larger the timeframe, the stronger the move. A monthly break of resistance typically moves more than a daily break.
Which Indicator is Best for Support and Resistance?
Like with timeframes, there’s no one best indicator for support and resistance trading. Multiple indicators showing the same support/resistance demonstrates high strength. When indicators match, it’s called confluence and indicates a high likelihood a certain move occurs.
How Do You Know When a Support or Resistance Will Hold?
For this, traders first look at the momentum going into the move. A holding support line will have ordinary low volume. The actual shape of candlesticks can also indicate if a rejection will occur, which is why candlestick pattern recognition is its own set of Technical Analysis.
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