Identifying support and resistance levels is the basic building block for understanding price action and improving your trading. If you are able to identify support and resistance lines in a financial trade, you can spot potential turning points or pin point entries better. In this Article I will be discussing the main methods of identifying support and resistance.
Classical bar charting is primarily concerned with studying trends and their breakdown. The patterns of classical bar charting tend either to reinforce pre-existing trends or destroy them. So pattern recognition has rightly become one of the most important skills to acquire for the technical trader.
Triangles, wedges, continuous Head and Shoulders drive the odds in favour of a trend continuing. Multiple Tops and Bottoms and Head and Shoulders reversals shorten the odds in a breakdown of a trend.
But recognition is not enough. This is because patterns imply a probable outcome and not a certainty. To actually trade the patterns and consistently make money the trader needs strategies to control the risk in case the pattern fails, and strategies to take profit in case the pattern works.
Traders need to enter and leave the market so that over time, on balance, they make money. But how should a trader decide where exactly to enter and exit the market?
This is where a close study of support and resistance levels both within and beyond patterns and trends becomes valuable. Optimistic traders in bull trends will study the market�s price action at support levels below for evidence that they are right or wrong and the trend has failed. Equally, they will study the market�s reaction to resistances above market to gauge whether the trend is losing steam or remains vigorous.
Identifying support and resistance levels on any chart and distinguishing the powerful levels from the weak should be second nature and is a powerful adjunct to pattern recognition. There are different types of support and resistance lines that you can identify.
The trend is the vital building block for traders � whether over a time length of five minutes or five years. Spotting a trend is easy because the definition is imprecise; a bull trend is a series of higher highs and higher lows; a bear trend is a series of lower highs and lower lows. But the support and resistance levels required to make trading decisions are very precise.
There are no supports in a bear trend. A prior law that has yet to be broken in a bear trend is best understood as a pivot rather than support. Pivots are areas of repulsion. The market may bounce off them or drive on through � and once through will accelerate on down. In a bull trend the reverse is true.
Patterns only have one support (or resistance) level that matters; the completion level. There are various patterns in classical technical analysis. The most common are triangles and wedges which are effectively contraction patterns. The price contracts until breaking out.
The pattern doesn�t exist before it has completed, but once completed, that upper diagonal is support. Completion means that the price has broken out. Once the price has broken out from the pattern, the breakout line becomes the new support or resistance level.
Similarly with a Head and Shoulders reversal pattern. The only support here is the completion level of the pattern, which is called the neckline.
It is precisely why there are so few supports and resistances in patterns per se that traders should look more widely for support and resistance levels to trade around once they are involved in a market.
Sometimes patterns and pre-existing trends still yield insufficient information to help traders. In that case Fibonacci inspired levels can create additional support and resistance. I won�t go into the history behind Fibonacci here, but it�s worth explaining that most charting packages or broker charts have Fibonacci tools built in. The most common is Fibonacci retracements, which involves drawing a line from a prior high (low) and a recent low (high). The charting program will automatically draw levels at which the price is likely to reverse. These levels are 38.2%, 50% and 62.8%.
If the market is retracing a trend move then the Fibonacci proportions can be powerful in an otherwise barren environment. If the market is pushing into previously uncharted territory then Fibonacci extensions can help.
Trends, completed patterns and Fibonacci derivatives all give rise to support and resistance levels. If all of these are charted on a single chart there may be many. Traders will need to sort the weak from the strong � the ones that really matter. Leaving aside the Fibonacci derived levels, horizontals should always be reckoned more powerful than diagonals for the simple reason that they present actual traded levels whereas diagonals levels are more subjective. With Fibonacci levels both retracement and extensions gain enormously in significance the more closely and frequently they are grouped by successive measurement within the same chart and from multiple timeframes.
The importance of studying support and resistance levels in multiple timeframes cannot be overestimated. Starting from the longest term chart (monthly), traders need to establish the important support and resistances and then transfer them to the medium term chart (weekly) of the same market. Then, having added any new medium term support and resistances that can be discovered, transfer all levels to a short term chart (daily). To
summarise:-
1) The study of support and resistance is vital for controlling a position: where to cut risk and where to take profit.
2) trends, patterns and Fibonacci constructions all give rise to support and resistance levels in a single chart.
3) Multiple timeframes give rise to still more levels.
4) The supports and resistances derived from all these timeframes can be simplified by assessing their importance and proximity to any given position.
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Andrew Tomkinson is a writer of Articles on the Financial Markets. For more information on a forex trading system that works, please go to the link:
http://budurl.com/EasyTrade
