February 11, 2014

Why You MUST Identify Support And Resistance To Improve Your Trading

Do you understand why support and resistance is so important to those who are day trading? It’s not some mystical chart pattern, there is a simple reason why these areas form on a chart, and if you don’t understand why that is you are setting yourself up for a lot of pain.

Support and resistance on a chart is as simple as this: the price of any market is always searching for volume. If there is volume above the previous high then the price will continue to trend up. If there is a lack of volume up above the previous high then the price will often reverse and start to search for volume near a previous low. When the price reaches a previous low, if there is volume below it, the price may break the support area and continue down. If there is no volume below the low, price will reverse once again and go searching for volume at the highs. The price is always searching for volume. This is the simple explanation.

The trading range will occur when there is neither volume up both the highs, or below the lows. Each time the price reaches a previous high or low it will reverse search of volume in the other direction. Until traders or market participants see value in the price beyond any highs or lows the market will stay in this range.

Identify Your Levels

It is essential that you start to identify areas support and resistance on your charts for any type of trading. Whether you’re a swing trader or day trading in any timeframe you need to know where the current support and resistance lies. If you understand you are taking a long into a resistance area then you will know to keep your stop tight and be ready to reverse the trade or cut the loss. Same goes for being short indoor resistance area, you can keep your stop tight whilst looking for a breakout will be ready to reverse the trade if you’re trading the range.

Here is a chart of the daily timeframe of General Electric. You can clearly see the trading range and support and resistance areas that were formed and the breakout that followed. If you are range trader you will be looking for failure at a previous high, or for a bounce of the previous low. If you are trend follower or breakout trader you will be looking for the price to break beyond these levels and to place your stop slightly back into the range in case of a fake out.

daily range

Support Or Resistance In A Trend

Support or resistance will form in any timeframe and it can be used in other ways apart from identifying a trading range. For instance, in this example the price of General Electric on a one-hour chart had started to form a downtrend. 99% of trends will retrace at some point before continuation in the direction of the trend, hence this is how we get high highs or lower lows. The price on this chart retraced and started to consolidate, then retested the top of the retrace before breaking the lower once again.

one hour trend

Often any small retrace in a trend will form a small support or resistance area as the price tests for volume in the opposite direction. If there is no volume the price will reverse and continue with the trend, this can often be a good entry point (or re-entry point) to piggyback the trend. As in the case with this one hour chart you can see at the end small double bottom formation as the price found no volume below the previous low. The price will now either test the resistance above again or go for another retest of the low, if there is volume beyond either of these the price will break in that direction. Now you just got have a strategy for that.

Open up your charts zoom out on any timeframe and run your eyes over the last few months or even years and look for those areas where the price has stalled more than once before. Draw horizontal line across those levels to where you are now. More often than not these levels will become an important area of something you really need to take note of.

Carl Croft

Carl is an active trader of forex, stocks and commodities who mainly uses charting and candlestick strategies. An author on various trading websites and is admin here!.