Support and resistance levels: Understanding and trading at these key market price levels

Support and resistance
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  • Support and resistance levels: Understanding and trading at these key market price levels

In financial markets, not all price levels are equal. Some attract more attention from investors than others, starting with support and resistance levels.

The concepts of support and resistance are at the heart of any chart pattern analysis. It is essential to be able to read, analyze, and understand stock market chart patterns. 

Although they are relatively simple to master in theory, it is a real challenge to know how to correctly interpret and trade at support and resistance levels in practice!

Key takeaways

Support and resistance levels are key price points that can help you buy or sell securities at the best price.

A support level is a low price zone offering a purchase opportunity. Conversely, a resistance level is a high price zone offering a sales opportunity.

Investor psychology and behavior play a key role in shaping support and resistance levels.

You can study historical stock data to identify support and resistance levels using chart pattern analysis and technical indicators.

WARNING

Trading exposes you to the risk of losing more than your initial investment and incurring financial liability. Trading is suitable only for well-informed, sophisticated clients able to understand how the products being traded work and having the financial ability to bear the aforementioned risk.

Transactions involving foreign exchange instruments (FOREX) and contracts for difference (CFD) are highly speculative and extremely complex. As such, they are subject to a high level of risk due to leverage. Please keep in mind that CDF trading is banned in the US.

Information published on the NewTrading.io website is for educational purposes only and should not be construed as offering investment advice or as an enticement to trade financial instruments.

What is a support level? 

A support level is a price zone in which security prices are likely to stop declining or even rebound and start rising again. 

By definition, the support level is always located below the current market price. This is a key price level at which buyers are likely to gain the upper hand over sellers and temporarily or permanently block a bearish movement.

What is a resistance level?

A resistance level is a price zone in which prices are likely to stop rising or even correct and start falling again.

By definition, the resistance level is always located above the current market price. This is a key price level at which sellers are likely to gain the upper hand over buyers and temporarily or permanently block a bullish movement.

Support and resistance
ProRealTime Web Platform Chart. In this example, the CAC 40 index moves between a support level (in green) and a resistance level (in red) several times as indicated by the arrows. When the market is stuck between two price levels, we are in a “range” situation. 
Noteworthy 

By convention, support levels are shown in green, and resistance levels in red. Stock market charts generally have several support and resistance levels that are major and to a certain extent, distant from the current price.

Understanding support and resistance levels

Resistance levels are the opposite of support levels, but they work the same way. When a security rises and crosses the resistance level, the key price level becomes a theoretical support level. Conversely, when a support level is pierced on the down trend, it becomes a theoretical resistance level. 

Areas of support and resistance are the result of increased activity by buyers and/or sellers who choose to take advantage of these key levels to enter or exit positions.

Rather than choosing random prices, investors prefer to select price levels resulting from more or less rational thought based mainly on technical analysis

Since investors often exhibit similar behavior, they tend to enter at similar price points, such as historically high or low price points, along the trend line, or using round numbers, to name a few.

Furthermore, the effectiveness of support and resistance levels depends largely on market consensus. The more obvious and stable a price level seems, the more likely it is that many investors will seek shelter in that security and therefore strengthen it even further.

Noteworthy 

The more times a key price point has been tested and validated by the market, the stronger it is considered to be. But beware, no support or resistance level is a sure thing!

Identifying the different types of support and resistance levels

Three methods of analysis help to identify support and resistance levels: 

Used separately or together, these methods of analysis help to identify different types of support and resistance levels, such as horizontal, oblique, or dynamic.

Horizontal support and resistance levels

Horizontal support and resistance levels correspond to fixed price levels which appear on the charts as horizontal lines.

Support and resistance
ProRealTime Web Platform Chart. In this example, the horizontal support and resistance levels of the CAC 40 index are represented by two horizontal lines.
Identification methodExamples
Extreme pointsThe last extreme high points for resistance levels, or the last extreme low points for support levels.
Round numbersThe psychological threshold of 40,000 points on the Dow Jones index, or round prices on a share ($10, $50, $100 etc.).
Historical benchmarkThe IPO price of a share, or the price at the beginning of a price gap.
Fibonacci levelsRetracements or extensions of Fibonacci levels following a trend movement.
Pivot pointThe pivot point, its support levels (S1, S2, and S3) and its resistance levels (R1, R2, and R3). 

Oblique support and resistance levels

Oblique support and resistance levels correspond to fixed price levels shown on the charts as ascending or descending lines.

Support and resistance
ProRealTime Web Platform Chart. In this example, the ascending oblique support level (green) and the ascending oblique resistance level (red) of the CAC 40 form a converging bevel.
Identification methodExamples
Trend linesThe last extreme high points of a trend for resistance or the last low points for support. 
Chart PatternsCanals, bevels, pennants, flags, and other popular chart patterns.
Drawing toolsSpeedline, Andrew’s Pitchfork, Gann’s Fan, and other popular drawing tools. 
Noteworthy 

Oblique support and resistance levels are characterized by a steady slope, but their price levels changes over time, either upwards (upward support and upward resistance) or downwards (downward support and downward resistance).

Dynamic support and resistance levels

Dynamic support and resistance levels correspond to variable price levels shown on the charts as curves and technical indicators.

Support and resistance
ProRealTime Web Platform Chart. In this example, the simple moving average of 200 days (pink dotted line) first plays the resistance role (red arrows) before playing the support role (green arrows).
Identification methodExamples
Moving averagesSimple, exponential, triangular, and other popular moving averages popular moving averages.
Donchian CanalThe Donchian channel’s upper resistance limit and its lower support limit.
Bollinger bandsThe Bollinger bands’ upper resistance envelope and its lower support envelope.
IchimokuThe different key levels of the Ichimoku indicator (Tenkan Sen, Kijun Sen, Chikou Span, and Cloud).

Tracing the support and resistance levels

Support and resistance levels can be traced manually using drawing tools, and they can also be automatically detected using the best trading platforms.

To manually trace a support or resistance level, first identify the key market price point, then draw a line passing through these points.

ProRealTime Web Platform drawing and plotting tools.

To automatically trace the support and resistance levels, simply select a security and click the auto trace button.

ProRealTime Web Platform Chart. In this example, the ProRealTrend tool automatically detected and traced the support (green) and resistance (red) levels.

Trading support and resistance levels

To correctly interpret the support and resistance levels, the accuracy of the levels is not as important as the investor behavior analysis regarding the levels.

Due to market noise, it is indeed relatively common for prices to briefly dip below a support level or rise above a resistance level without being significantly impacted.

Rather than trading support and resistance levels exactly at their price points, traders play it safe, remaining a good distance from these key points so as not to fall victim to random short-term movements.

Traders can consider two opposite strategies when confronted with support and resistance levels: fade and breakout trading.

Fade trading strategy

The strategy behind fade trading (or fading) is to bet on the strength of a support or resistance level.

In a buy-sell situation, traders place a buy order near the support level, a stop-loss order just after it, and a take-profit order just before the next resistance level.

Support and resistance
ProRealTime Web Platform Chart. In this example, the trader is using a buy-sell fade trading strategy. The idea is to buy near the support level (blue dotted line). A stop-loss order is placed just after the support level (red dotted line). The sell/take-profit order is placed just before the resistance level (green dotted line).

In the case of a short sale, traders place a sell order near the resistance level, a stop-loss order just above, and a take-profit order just above the next support level.

Support and resistance
ProRealTime Web Platform Chart. In this example, the trader is using a short-sale fade trading strategy. The idea is to place a sell order near the resistance level (blue dotted line) and a buy order further down before the support level (green dotted line). The stop-loss order is placed just above the resistance level (red dotted line).
Noteworthy 

Traders often use limit orders to buy on a support level or sell on a resistance level to optimize the accuracy of their entry point.

Breakout strategy

The idea behind a breakout strategy is to bet that prices will accelerate once a security crosses the resistance level or breaks through the support level.

In a buy-sell situation, traders place a buy order once the security breaks through and crosses the resistance level, a stop-loss order just below, and a take-profit order near the next resistance level.

Support and resistance
ProRealTime Web Platform Chart. In this example, the trader is using a buy-sell breakout strategy. The idea is to buy just after the security crosses the resistance level (blue dotted line) and place a sell order higher up (green dotted line). A stop-loss order is placed just below the resistance level (red dotted line).

In a short-sale situation, traders place a sell order once the security breaks through the support level, a stop-loss order just above the support level, and a take-profit order near the next support level.

Support and resistance
ProRealTime Web Platform Chart. In this example, the trader adopts a short-sale breakout strategy. The idea is to sell once the security crosses the support level (blue dotted line) and to buy further down (green dotted line). A stop-loss order is placed above the support (red dotted line).
Noteworthy 

Traders often use stop-loss orders to buy after a security crosses the resistance level or to sell after it breaks through the support level.

Traders rely on several factors to determine whether to bet on the strength or failure of a key price level:

  • The underlying trend
    By definition, with a bullish underlying trend, support levels are more robust than resistance levels. Conversely, with a bearish underlying trend, resistance levels are more robust than support levels.
  • Volumes
    The increase in volume near support and resistance levels demonstrates that the market is interested in this key level. This price is unlike any other, which could encourage the market to take a break.
  • The resilience of the tested level
    The more successful a price level has been in the past, the more investors tend to trust it. But beware, if prices have more and more difficulty bouncing back near a support level or receding near a resistance level, they could collapse sooner or later.
  • Technical indicators
    Several indices can predict whether or not a key price level will be crossed, including those that measure the strength of a trend, price volatility, and price amplitude. In an attempt to guess whether support and resistance levels will be crossed, traders often use technical indicators.

Buy support levels and sell resistance levels as part of a fade trading strategy. Or, buy securities crossing resistance levels and sell securities breaking through support levels as part of a breakout strategy. This is one of a trader’s biggest dilemmas.

Fade trading or breakout trading? Before you choose a side, take advantage of some risk-free training on one of the best trading simulators!

author
Maxime Parra

Maxime holds two master’s degrees from the SKEMA Business School and FFBC: a Master of Management and a Master of International Financial Analysis. As founder and editor-in-chief of NewTrading.fr, he writes daily about financial trading.

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