Support and resistance are specific price areas or price levels which either support prices on declines in up trends or which resist prices on rallies in down trends.
In an up trend, short term and day traders will attempt to buy at support or at levels of support. In a down trend, short term and day traders will attempt to sell at resistance levels or in resistance areas.
If support and resistance levels cannot be determined, then you cannot define concise levels in which to establish entry or exit positions in your specific trade. It is of utmost importance for traders to develop effective strategies and methodologies for calculating support and resistance levels. These levels can be determined with the use of various trading tools like Point and Figure charts, Fibonacci numbers and Gann angles.
Day traders is in a definite advantage when it comes to the use of support and resistance levels, in as much that the day trader's trade normally end when the trading day is over and if a bad trade or decision was made based on support or resistance levels it will not be repeated in the next trading day.
Determining support and resistance levels are somewhat different for the day trader than the position trader. This is because support and resistance levels for the day trader must be closer to the current market price that they are for the long term or position trader. Markets can only drop so far in one day, and consequently the determination of support and resistance levels by the day trader must be realistic in terms of what can be expected - however this does mean that day traders must be willing to use realistic technical support and resistance levels in order to establish their positions.
The following rule may appear very simple, yet it is enormously effective at isolating support and resistance levels and can be applied profitably in any market:
1. Follow a 3-day moving average of the highs, and a 3-day simple moving average of the lows.
2. Take the 3-day moving average of the highs to act as your resistance level, and the 3-day moving average of the lows to act as your support level.
3. Add a filter by drawing in the support of the lows if the trade has made a 3-day high in say, the last 3 days (you can use four or five days, depending on your trading methodology) This means that you will only draw in the 3-day moving average of the highs if the stock has made a 3-day low in the last three days - this means that you only want to sell when the short term is down.
This is a very simple method of trading stocks and commodities on a daily basis, and if calculated correctly they will work.
In up trends, every time price drops to the up trend line and then resume their advance, the trend line has acted as support to the price up trend. Support can also be found at prices of previous support or resistance.
In down trends, every time price rises to the down trend line and then resume their decline, the down trend line has acted as resistance to the upward move of market prices.
Resistance can also be expected at prices of previous support or resistance. Once levels of support or resistance have been violated then invariably these reverse their roles, so that previous support becomes resistance and previous resistance becomes support.
Consider the following. When price action drops to a certain level the bulls (i.e., the buyers) take control and prevent prices from falling further. Similar to support, a "resistance" level is the point at which sellers take control of prices and prevent them from rising higher.
The price at which a trade takes place is the price at which a bull and bear agree to do business. It represents the consensus of their expectations. The bulls think prices will move higher and the bears think prices will move lower.
Support levels indicate the price where the majority of investors believe that prices will move higher, and resistance levels indicate the price at which a majority of investors feel prices will move lower.
When investor expectations change, they often do so abruptly. Note how when prices rose above the resistance level they did so decisively. Also similarly with support.
The development of support and resistance levels is probably the most noticeable and reoccurring event on price charts.
The penetration of support/resistance levels can be triggered by fundamental changes that are above or below investor expectations (e.g., changes in interest rates, government announcements, etc.) or by self-fulfilling prophecy (investors buy as they see prices rise). The cause is not as significant as the effect, new expectations lead to new price levels.
As you can see from the charts above. Some times the price will just keep going through support and resistance and sometimes it will come back to test its previous support or resistance line. This applies also to trend lines. We will be going into this in more detail in future chapters when we cover learning to trade.
It is essential to understand the concept of support and resistance. The validity of a trend line is dependent on its duration and the number of times it has been successfully tested.
The longer the trend line has been in effect and the more times it has been successfully tested the more important the trend line becomes. Consequently when a trend line of long duration, which has been successfully tested many times, has been violated then an important reversal of trend has likely occurred.
However, on no account exit the market until definitive evidence of trend termination has occurred. Remember another trading mantra -- The trend is the trend until proved otherwise -- to ignore this dictum is to unnecessarily deny yourself profits.
Both E.j Sieberhagen & Martin Chandra are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
E.j Sieberhagen has sinced written about articles on various topics from Stock, Forex Guide. For more online stock trading information please visit http://www.stocktradinginformation.net/ - a popular online stock trading website that provides stock trading information for beginner traders.. E.j Sieberhagen's top article generates over 1900 views. to your Favourites.
Martin Chandra has sinced written about articles on various topics from First Date, Forex Guide and Forex Online. is a full-time investor. He has been researching investment strategies and make his own living. For more information please go to. Martin Chandra's top article generates over 9900 views. to your Favourites.