Support refers to a level on the chart under the market where buying interest is thought to be stronger than selling interest causing price to stop and reverse upwards. Support is normally identified by a previous low or series of lows. Resistance is the opposite of support.
In an uptrend, each successive low should be higher than the preceeding one. Each peak should be higher the the previous one. When the market fails to make a higher high, and break below support this suggests possible trend reversal.
When a support or resistance level is significantly violated the reverse – a violated support level becomes resistance.
The more trading that takes place at a given price area the more significant it becomes – because more market participants have a vested interest in that area.
Three principle factors determine the strength of support and resistance levels:
– The longer the period of time a price trades in a specific area of support or resistance the greater the significance of the level.
– Volume is another way to gauge the importance of a level – the more volume of trading that takes place the more significant the level.
– The more recent the activity the more significant the level – the reason being that the level is influenced by the positions of traders currently in the market.
What constitutes a significant violation of a support or resistance level? 3% penetration is a benchmark for major levels, while shorter term levels require a lower number like 1%.
Round numbers often act as support and resistance levels. Avoid placing stops at large round numbers, or entering trades there as the price may not reach that level due to the high volume of orders.
Trendlines as Support and Resistance
For a trendline to be drawn there must be evidence of a trend – for an uptrend there must be at least two reaction lows with the second above the first. To confirm the validity of the trendline it should be touched a third time.
The up trendline can provide support for the trader buying the dips in the uptrend. A violation of the trendline is an early indicator of trend reversal.
Two factors determine the strength of a trendline – the number of times it has been tested and the length of time it has been intact.
Moving Averages as Support and Resistance
In an uptrend moving averages will act as support, conversely in a downtrend moving averages will act as resistance.
Fibonacci Levels as Support and Resistance
Fibonacci Retracement levels identify possible areas of support and resistance.
Pivot Points as Support and Resistance
Pivot Points offer a trader support and resistance levels for a specific time frame. The pivot itself which is used to indicate directional bias for the session is accompanied by a first and second level of support and resistance.