Support and Resistance are common terms that traders use to describe levels where price is more likely to stop moving in one direction or change direction.
Support refers to levels where price might reverse and move higher or a level that slows the momentum of price moving down. Resistance refers to levels where price might reverse and move lower or a level that slows the momentum of price moving up. Support or resistance is determined by whether price is above or below the level identified by the trader.
Generally, a trader can think of support being levels below price whereas resistance is formed above price. Levels of support and resistance can be formed in a few different ways. Moving averages, previous highs and lows, key price levels, and trend lines are the main indicators that traders use to find levels of support and resistance.
Traders will use moving averages of various lengths to indicate levels of support and resistance. Moving averages below price will form levels of support and moving averages above price will create levels of resistance.
Traders can add more than one length moving average to visualize initial and deeper levels of support and resistance. For example, a trader might add the 21, 100 and 200 period exponentially moving averages to their charts.
Typically, the shorter the length of the moving average, the weaker the support or resistance it creates. This means, for example, price will move through a 9-period moving average on a 5min chart more often than a 100-period moving average. The 100-period moving average is considered to provide stronger support for price when compared to the 9-period moving average. Traders can use any moving average that they like, some common lengths are the 9, 21, 50, 100 and 200 period moving averages.
Traders might use the 100-period moving average on a daily chart to indicate stronger and longer term levels of support and resistance. Price may only move this far every few months.
As price moves to areas that a trader believes is support or resistance, moving averages will be used to pinpoint areas that price could move through or bounce of off. For example, if price is moving up then retraces to the 55-period moving average, then starts to move back up, there is a good chance that the level will hold as support, and price will start to move in the direction of the original trend again.
If price moves to the moving average and does not bounce, there is a good chance that it will move to lower levels of support. If price is already at lower levels of support such as the 200-period moving average, then it could be an indication of a longer-term change in trend. It could indicate that price is moving from an uptrend to a down trend and vice versa.
Previous Highs and Lows
Technical analysts believe that price has a memory and that trends will repeat. There are certain price levels where traders will act a certain way. For example, traders might decide that Crude Oil is a strong buy at $50 after a retracement from higher levels, or that the S&P 500 is a strong buy at 2000. This is what creates tops and bottoms in the market.
If there is enough interest a key level, when the market gets back to that level traders seem to behave in a similar fashion over time. Because of this market tendency, technical analysts may look at where a market made previous highs and lows and use these levels as support and resistance. Markets will tend to pause at previous highs and lows. For example, if a market is moving up it will tend to encounter resistance at a previous high. If a market is moving down it will generally find support at previous lows.
If price breaks through support, then it will generally continue in that direction.
When price breaks through support or resistance, these levels will reverse, support will become resistance and resistance will become support. For example, if price breaks through support then that level of support will become resistance when price moves back up. The same will occur if price moves through resistance, the previous level of resistance will tend to become support when price moves back down.
Support and resistance can also be observed at certain price levels. For example, specific prices will create levels where price will find support or resistance because this is where there is potentially increased interest in trading that particular market. For example, the daily chart of CL shows how over a few years the $100 level in crude could not be successfully broken by more than a few dollars, and each time it attempted to break out, price retraced.
Trend lines act like moving averages, except they are based on the highs and lows that price makes. In this example, this daily chart of the ES shows how a trend line can act as support.
In a market that is moving up, a trend line would be drawn through a series of lows in price. This creates an upward sloping line. The theory is this line can be extended past current price and will support price as it moves back down towards the trend line.
A trader can also draw a line through the series of highs that the same market has made creating a channel, where price will in theory stay contained.
The same lines can be drawn for markets that are in a down trend.
Levels of support and resistance offer traders insights in to areas where price might stop trending and retrace or where retracements might stop, and price will begin to move in the direction of the original trend. Traders should be aware that support and resistance will not always hold to the penny, rather they are zones that can be identified in a market which might be favorable for traders to enter or exit a trade. Support and resistance levels offer another piece of information that can be included in a trader’s assessment of the market.
Peter Knight Advisor