DAY TRADING  TRADING STRATEGIES

How To Trade Based on Support and

Resistance Levels
How to Use Support and Resistance to Make Better
Trading Decisions
o Share
o Pin
o Email

BY CORY MITCHELL
 
Updated August 20, 2018

Support is where the price tends to stop falling, and resistance is where the price
tends to stop rising. Yet, trying to make trading decisions based on this vague
definition will likely lead to a depleted trading account.

To use support and resistance effectively we first need to understand how asset
prices typically move, so we can then interpret support and resistance from that
framework. There are also different types of support and resistance, such as
minor and major/strong. We expect minor levels to be broken, while strong levels
are more likely to hold and cause the price to move in the other direction. With
this information we can start making better decisions based on support and
resistance.

 01

 Trends, Ranges and Support and Resistance

EURUSD 1-Minute Chart with Various Types of Support and Resistance. MT4

Support and resistance are highlighted with horizontal or angled lines,

called trendlines. If the price stalls and reverses in the same price area on two
different occasions in succession, then a horizontal line is drawn to show that the
market is struggling to move past that area.

In an uptrend, the price makes higher highs and higher lows. In a downtrend the
price makes lower lows and lower highs. Connect the highs and lows during a
trend. Then, extend that line out to the right to see where the price may
potentially find support or resistance in the future.

These simple lines highlight trends, ranges, and other chart patterns. They
provide traders with a visual of how the market is currently moving and what it
could do in the future.

 02

 Major and Minor Support and Resistnace

Gold futures 1-minute chart with minor and major support and resistance. MT4

Minor support and resistance levels are expected to be broken. For example, if
the price is trending lower, it will make a low, then bounce, and then start to drop
again. That low can be marked as a minor support area since the price did stall
out and bounce off that level. But since the trend is down, the price is likely to
eventually fall through that minor support level without much problem.

Minor support or resistance provide analytical insight, and potential trading

opportunities (discussed later). In the example above, if the price does drop
below the minor support level then we know the downtrend is still intact. But, if
the price stalls and bounces at or near the former low then a range could be
developing. If the price stalls and bounces above the prior low then we have a
higher low and that is an indication of a possible trend change.

Major support and resistance are price areas that have caused a trend reversal
recently. If the price was trending higher and then reversed into a downtrend,
where the price reversed from is a strong resistance level. Where a downtrend
ends and an uptrend begins is a strong support level.

When the price comes back to a major support or resistance area it will often
struggle to break through it and move back in the other direction. For example, if
the price falls to a strong support level, it will often bounce upward off it. The
price may eventually break through it, but typically the price retreats from the
level a number of times before doing so.

 03

 Trading Based on Support and Resistance

Gold futures 1-minute chart with potential trades based on trend and support and
resistance. MT4

The basic trading method for using support and resistance is to buy near support
in uptrends, ranges, or chart patterns, and to sell/short-sell near resistance in
downtrends, ranges, and chart patterns.

It helps to isolate a longer-term trend, even when trading a range or chart

pattern. The trend provides guidance on the direction to trade in. For example, if
the trend is down but then a range develops, preference should be given to
short-selling at range resistance instead of buying at range support. The
downtrend lets us know that going short has a better probability of producing a
profit than buying. If the trend is up and then a triangle pattern develops, favor
buying near support of the triangle pattern.

Buying near support or selling near resistance can pay off, but there is no
assurance that the support or resistance will hold. Therefore, consider waiting for
some confirmation that the market is still respecting that area.

If buying near support, wait for a consolidation in the support area and then buy
when the price breaks above the high of that small consolidation area. When the
price makes a move like that it lets us know the price is still respecting the
support area, and also that the price is starting to move higher off of support. The
same concept applies to selling at resistance. Wait for a consolidation near the
resistance area, then enter a short trade when the price drops below the low of
the small consolidation.

When buying, place a stop loss several cents below support, and when shorting
place a stop loss several cents above resistance.
If waiting for a consolidation, place a stop loss a couple cents (or ticks or pips)
below the consolidation when buying. When selling, the stop loss goes a couple
cents above the consolidation.

When entering a trade, have a target price in mind for a profitable exit. If buying
near support, consider exiting just before the price reaches a strong resistance
level. If shorting at resistance, exit just before the price reaches strong support.
You can also exit at minor support and resistance levels. For example, if buying
at support in a rising trend channel, consider selling at the top of the channel.

In some cases, you may be able to extract more profit if you let a breakout occur,
instead of selling at minor support/resistance. For example, if buying
near triangle support within a larger uptrend, you may wish to hold the trade until
it breaks through triangle resistance and continues with the uptrend.

There is also a concept that old support can become new resistance or vice
versa. This isn't always the case but does tend to work well in very specific
conditions.

 04

 False Breakouts

False breakout Strategy Example (ES Futures, 610 Tick Chart). NinjaTrader

Asset prices will often move slightly further than we expect them to. This doesn't
happen all the time, but when it does it is called a false breakout. If our analysis
shows that there is support at $10, it is quite possible that the price could drop
through $10, to $9.97 or $9.95 for example, and then start to rally again. Support
and resistance are areas, not an exact price. Expect some variability in how the
price acts around support and resistance. It is unlikely to stop at the exact same
price as before.

False breakouts are excellent trading opportunities. One strategy is to actually

wait for a false breakout, and enter the market only after it occurs. For example, if
the trend is up, and the price is pulling back to support, let the price break below
support and then buy when the price starts to rally back above support.
Similarly, if the trend is down, and the price is pulling back to resistance, let the
price break above resistance and then short-sell when the price starts to drop
below resistance.

The downside to this approach is that a false breakout won't always occur.
Waiting for one means good trading opportunities will be missed. Therefore, it is
typically best to take trading opportunities as they come. If you happen to catch
the odd false breakout trade, that's a bonus.

Because false breakouts occur on occasion, that is why our stop loss is placed a
bit of distance away from support or resistance, so that the false breakout isn't
likely to hit our stop loss before moving in our anticipated direction.

 05

 Adapting Trading Decisions to New Support and Resistance Levels

KTSDESIGN/SCIENCE PHOTO LIBRARY/Getty Images

Support and resistance are dynamic, and our trading decisions based on them
must also be dynamic. In an uptrend, the last low and last high are what is
important. If the price makes a lower low it indicates a potential trend change, but
if the price makes a new high that helps confirm the uptrend. Focus your
attention on the support and resistance levels that matter right now. Trends often
encounter trouble at strong areas. They may eventually break through, but it
often takes time and multiple attempts.

Mark major support and resistance levels on your chart, as they could become
relevant again in the future if the price approaches those areas. Delete them
once they are no longer relevant. For example, if the price breaks through a
strong support or resistance area and continues to move well beyond it. The level
is broken and it is no longer of much use to us.

Also, mark the current and relevant minor support and resistance levels on your
chart. These will help analyze the current trends, ranges, and chart patterns.
These minor levels lose their relevance quite quickly as new minor support and
resistance areas form. Keep drawing the new support and resistance areas, and
delete support and resistance lines which are no longer relevant (price has
broken through them).

If day trading, focus on today and don't get too bogged down with figuring out
where support and resistance is from prior days. Trying to look at too much
information can easily result in information overload. Pay attention to what is
happening now, and mark today's support and resistance levels as they form.

Trading off support and resistance takes lots of practice. Work on isolating
trends, ranges, chart patterns, support, and resistance in a demo account. Then
practice taking trades with targets and stop losses. Only once you are profitable
for several months with your support and resistance trading method should you
consider trading real money.