Support and Resistance
The point at which a trend stops or makes a pause is a support or resistance, depending upon the direction of the move. If it is not confined to a singular point, and reverses from a series of points, in a vicinity, then it is a support zone or resistance zone. There isn’t any indicator in default as support and resistance indicator to identify the dynamic supply and demand change. However, specific indicators’ functionalities can be extrapolated to a support and resistance indicator.
Support is any price point which prevents the price from falling further. And depending on whether it renders a temporary pause or a permanent reversal, the support defines its strength.
The demand is higher than the supply at supports.
In the above hourly chart of USD/JPY, support is the point that acts as demand zone and resumes the bullish trend. The pair bounces off from each supportive point and creates a new high which validates the support.
How to identify support?
Draw a straight line from the bearish reversal points.
If the line connects more than 3 reversal points, then the line becomes a valid historical support.
It becomes a critical point, in the future, as traders tend to use it as reference for long trades.
In the above EUR/GBP chart, the market bounces off from the same point, 0.83359 thrice. It indicates a strong demand for the asset. These kinds of strong supports are indeed the best entry points for long trades.
It is not always possible for the market to bounce back from a single point precisely, every time. So, it bounces off from points which are at close proximity to a support and converts it to a zone.
It is relatively difficult to comprehend the support zone on short time-frames. Longer time frames can spot the support zone with ease.
The above chart is a weekly chart of EUR/USD. The pair finds support not a point, but at a broad range, 1.03500 to 1.06000 and hence becomes a zone.
In practice, zones are more potent than a point as they are difficult to breakthrough.
Resistance is a point that makes the price action to pause or change its course during a rise.
The supply is more than the demand for resistance.
In the hourly chart of EUR/CAD, each time the pair makes a pullback, the supply rich points which revive the downtrend is the resistance. These points are good entry points for short trade.
How to identify a resistance?
Draw a straight line connecting the reversal points.
If three or more points kisses the line, then it becomes a resistance.
The number of times it has reversed is directly proportional to its strength.
Remember, when something happens twice its a coincidence, but if it happens thrice, it becomes a pattern. And validates it. The same applies to trendline too. Get to know the #7 Common Mistakes of New Forex traders.
As indicated in the daily chart of USD/CHF, point 1.00415 acts as a strong resistance. Each time it meets the mark of 1.00415, it acts as a wall and instigates a sharp down move.
Similar to the support zone, the resistance zone identifies the cluster of resistance points amid fluctuations.
The reason for the price to be resisted by a bunch of points is beyond comprehension.
Sometimes, the fundamental factors have a say too. But, the occurrence is comparatively higher in long-term charts.
In the above chart, the price range of 1349-1366 acts as a critical resistance zone in Gold.
Its valiant effort to break the area proved in vain.
The bullion metal, at last, plunged from the zone which only validated the resistance.
Support and Resistance Indicator (Advanced methods)
The price action identifies the static supports and resistances easily. But the supply and demand vary dynamically at different instances and at different periods.
It is difficult to spot these supply and demand zones which supports and resists price action using conventional methods. The indicators like moving average, Fibonacci tools and pivot points identify supply and demand zones at specific instances and timeframes, depending on the trend, and hence known as support and resistance indicator.
Moving Average as Support
A moving average supports the price in many instances. It helps in the resumption of a trend after a correction in a directional move. Therefore, the best entry points in a trend move are when prices are at the support zone around the moving averages.
In the above chart, the 100-SMA supports price action and holds the trend move. Every time the price hits the SMA, the trend revives. Or you can say, the moving average literally drives the price here.
Moving Average as Resistance
In a downtrend, moving averages resist pullback and serve as the supply prone zone. They push the price down, keeping the bearish sentiment afloat.
In the above chart, the zone in and around the 100-SMA resists the pullback and resumes the downtrend. In this case, moving average acts as a resistance zone. And both SMA and EMA can play the role of support and resistance indicator. Get to know more about simple and exponential moving average, their application and strategies here.
Fibonacci Retracement and Extension
This is the best support and resistance indicator a trader can ask for. In an uptrend, the Fibonacci retracement points are the strong demand zones, whereas the Fibonacci extension points are the supply zone (vice versa for the downtrend).
The Fibonacci retracement levels 0.236, 0.382, 0.5, 0.618 are strong supports in any directional move. They act as a good supply or demand zone depending on the type of trend. Likewise, the Fibonacci extensions, especially the 1.618 point, resist (in an uptrend) or supports (in a downtrend) the price action. Human beings (traders are humans too) tend to react to the Fibonacci values and it plays, psychologically, a great part in a trader’s decision making. (Read more about humans and Fibonacci number here)
The above chart is a fine example of the Fibonacci indicator being a support and resistance indicator. The GBP/JPY pair, in a downtrend, makes a pullback. The 0.5 retracement value of the previous trend move resists the price action strongly. It caps the price and sends it down. Likewise, the 1.618 extension point upholds the falling price.
Both these points were not significant points based on previous price action. But, it became significant courtesy to Fibonacci numbers. Get to know more about Fibonacci number application in Elliott wave here.
The pivot point is the best intraday support and resistance indicator. It indicates the supports and resistances for the day, based on the previous day’s movement. If you are an intraday trader, these values are of pivotal importance to you.
Role reversal – Perfect way to trade support and resistance
Whenever support breaks, it then resists the price action. Likewise, a resistance upholds the price action when price breakthroughs. Experienced traders use these role reversal instances to validate the breakout.
So, don’t initiate a trade as soon as the support or resistance breaks.
Wait for the price action to pullback or throwback to the same level.
Then initiate a trade.
It dampens your risk as well as avoids traps. Hence, it is undoubtedly the best entry point.
In the above example, the point 0.90013 initially resists the price action. Once the pair breaches and passes the resistance of 0.90013, it then converts itself to a supply zone.
Want to spot reversals? Here is a modern harmonic pattern – the dragon pattern here.
The demand prone zone lends support to an asset. Likewise, the supply rich zone resists the price action.
The zones are stronger than a point.
The strength of the support and resistance zone is directly proportional to the number of times it rendered reversal.
Moving averages, Fibonacci retracements and extensions can be extrapolated as support and resistance indicators.
A support or resistance, upon breakthrough, converts itself to the other. It is the best instance to initiate a trade.