How to successfully trade support and resistance

The pattern formed by the movement of the price of a security is known as price action pattern. It is a method of trading which relies heavily on the price of the security; although other factors, like technical analysis, can also be used in conjunction with the price of the security. The security could be anything – equities, bonds, indices, currency, commodities, derivatives, etc.

How to Find Support and Resistance Levels

As shown in the chart below:
support and resistance

S&P 500 – June 5, 2017

Support level is a horizontal price level that connects price bar lows to other price bar lows.

Resistance level is a horizontal price level that connects price bar highs to other price bar highs.

Support and resistance levels are formed:

1- When the price of a security fails to move below a price level – Support Level

2- When the price of a security fails to move above a price level – Resistance Level

In the figure above it can be seen that the support, and, the resistance levels have given a trading range to the price. In other words, price oscillates between the support, and, the resistance level; in a trading range.

The chart below is an extension of the chart above, and, it can be seen that the price eventually broke down.

support and resistance

S&P 500 – June 5, 2017

In this case the support level was violated by the price. However, even the resistance level can be broken. Whenever either the support or the resistance level is broken, the price moves swiftly in this broken direction, and, after some time it will visit this level again to test it. This can be confirmed by the extended chart shown below:

support and resistance

S&P 500 – June 5, 2017

The initial support level has now become a resistance level; as the price was unable to move above it. Moreover, it fell again, after trying to move above it.

Generally; not always – if a support level is broken, it becomes a resistance level; and, when a resistance level is broken, it becomes a support level.

Support and Resistance Trading Strategy

If the price remains in the trading range (as shown below), we know we should buy at the support level, and, sell at the resistance level.

support and resistance

S&P 500 – June 5, 2017

However, we don’t know if, and, when these levels would be broken. With this in mind let’s devise a strategy to trade:

1- Identify the support, and, the resistance levels; by looking at the chart for a while.

2- Once the levels are decided, the trader should buy after the price has moved somewhat above the support level with a stop loss order placed slightly below the support price level.
(A stop loss order is an order which is executed if the price moves against the desired direction, and, goes to the price at which the stop loss order has been placed.) – This will insure the loss is limited just in case the reverse movement happens.

Support and Resistance Example 1:

First up, and, the down arrows are used to decide the support, and, the resistance price levels. After deciding the support, and, resistance price levels, the trader should buy when price has moved somewhat above – after bouncing up from the second up arrow.
Remember, to place a stop loss order at a price below the support level price. If the price keeps moving up after buying, the trader should book profit around the resistance price level.

S&P 500 – June 5, 2017

3- Once the levels are decided, the trader should sell after the price has moved somewhat below the resistance level with a stop loss order placed slightly higher than the resistance price level.
(A stop loss order is an order which is executed if the price moves against the desired direction, and, goes to the price at which the stop loss order has been placed.) – This will insure the loss is limited just in case the reverse movement happens.

Support and Resistance Example 2:

First up, and, the down arrows are used to decide the support, and, the resistance price levels. After deciding the support, and, the resistance price levels, the trader should sell when the price has moved some somewhat below – after bouncing down from the resistance price level. Remember, to place a stop loss at a price higher the resistance level price. If the price keeps moving down after selling, the trader should book profit around the support price level.

support and resistance

S&P 500 – June 5, 2017

So far so good – buy at support level, and, sell at resistance level. However, this party won’t continue for long, and, sooner than anticipated either of the levels would be broken. How to find out which level would be broken? – Support or Resistance.

To know this, we need to look at the total number of buyers, and, the total number of sellers at each of the arrows. (this information can be found in your trading terminal – when you check about the details of the security; you intended to trade. Total number of buyers, and, total number of sellers change in real time – if you not sure how to get this, ask your broker!)

At down arrows (that is at resistance level) the number of seller should be considerably higher that the number of buyers for the price to reverse direction, and, go back to the support level.

At up arrows (that is at support level) the number of buyer should be considerably higher that the number of sellers for the price to reverse direction, and, go back to the resistance level.

However,

1- If the support level must break, the total number of sellers would be more than the total number of buyers. *

2- If the resistance level must break, the total number of buyers would be more than the total number of sellers. *
*Not a strict rule, but it is a good indicator.

support and resistance

S&P 500 – June 5, 2017

Conclusion

· Don’t get carried away by choosing every level of the chart to find support and resistance levels. Look at the chart for a while to figure out clear cut trading range.

· Use this strategy, if and only, if a clear trading range is spotted.

· The horizontal lines of support or resistance won’t always touch the exact lows or highs, respectively. This is not an exact science. Slight deviations can be ignored.

· Always use stop loss.

-J

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