How To Trade Based on Support and Resistance Levels

support and resistance

Simply put, an area of support is where the price of an asset tends to stop falling, and an area of resistance is where the price tends to stop rising. But traders really need more information about support and resistance beyond those simple definitions before they attempt to make trading decisions based on those areas in a chart.

To use support and resistance effectively, you first need to understand how forex prices typically move, so you can then interpret support and resistance from that framework. You also need to be aware that there are different types of support and resistance, such as minor and major/strong. Minor levels are expected to be broken, while strong levels are more likely to hold and cause the price to move in the other direction.

Understanding Support and Resistance Levels

A Support Level or a Resistance Level is a price level that the market has rejected at least twice and is keeping the market from reaching through to new levels. The support/resistance of an identified level is deemed to be stronger the more times that the price has historically been unable to move beyond it.

There could be many reasons as to why the price has been rejected at these levels; accumulation of buy orders (at a support level), or sell orders (at a resistance level); buyers are attracted by the lower levels (support level), or sellers attracted by the higher levels (resistance level); buyers think or feel the market will go higher (support), or sellers think or feel the market will go lower, etc.

Support/resistance is often found at a round price level such as 0.9000 or 1.1000. Many inexperienced traders tend to buy/sell when the price is at a whole number because target prices/stop orders set by retail traders and some large institutional traders are placed at round price levels rather than at prices such as 0.9004 or 1.9234. Because so many stop-loss orders or pending entry orders are placed at the same level, these round numbers tend to act as strong price barriers. Many technical analysis traders will use their identified support and resistance levels to choose strategic entry/exit prices because these areas often represent the prices that are the most influential to an asset’s direction.

3 Simple rules to draw perfect support and resistance levels

  • Rule No. 1: Price needs to get rejected at least twice from the level
  • Rule No. 2: The more rejections the level has, the more important it becomes
  • Rule No. 3: Most recent rejections are more important than less recent rejections


Continue reading or play around in a risk-free demo account and practice trading using the best support and resistance tools. 

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Support and Resistance Indicators

Trendlines

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.

>> How a simple trendline can improve your trading success

Fibonacci 

Fibonacci is a very popular tool among technical traders and is based on the key numbers identified by mathematician Leonardo Fibonacci in the thirteenth century. 

Price Action Traders use the Fibonacci retracement or extentsion levels as potential support and resistance areas. Since so many traders watch these same levels and place buy and sell orders on them to enter trades or place stops, the support and resistance levels tend to become a self-fulfilling prophecy. Traders also use the Fibonacci extension levels as profit taking levels.
 
Again, since so many traders are watching these levels to place buy and sell orders or to take profits, this tool tends to work more often than not due to self-fulfilling expectations.
 

Pivot Points

Pivots Points are significant levels chartists can use to determine directional movement and potential support/resistance levels. Pivot Points use the prior period's high, low and close to estimate future support and resistance levels. In this regard, Pivot Points are predictive or leading indicators. There are at least five different versions of Pivot Points. 

Pivot Points were originally used by floor traders to set key levels. Like modern-era day traders, floor traders dealt in a very fast-moving environment with a short-term focus. At the beginning of the trading day, floor traders would look at the previous day's high, low and close to calculate a Pivot Point for the current trading day. With this Pivot Point as the base, further calculations were used to set support 1, support 2, resistance 1, and resistance 2. These levels would then be used to assist their trading throughout the day.

>> What is a Pivot Point and how to use in Trading

Major and Minor support and resistance levels

Minor support and resistance levels don't hold up. 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.

Areas of minor support or resistance provide analytical insight and potential trading opportunities. 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 areas are price levels that have recently caused a trend reversal. If the price was trending higher and then reversed into a downtrend, the price where the reversal took place 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.

Trading Based on Support and Resistance 

The basic trading method for using support and resistance is to buy near support in uptrends or the parts of ranges or chart patterns where prices are moving up and to sell/sell short near resistance in downtrends or the parts of ranges and chart patterns where prices are moving down.

It helps to isolate a longer-term trend, even when trading a range or chart pattern. The trend provides guidance on the direction of 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 sell at resistance. Wait for 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 (or ticks or pips) below support, and when shorting, place a stop loss several cents, ticks, or pips above resistance.

If you're waiting for a consolidation, place a stop loss a couple of cents, ticks, or pips below the consolidation when buying. When selling, the stop loss goes a couple of cents, ticks, or pips 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 you're 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 you're 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, such as a second chance breakout.

MT5 Support and Resistance Indicators

There are many MT5 support and resistance indicators in the market for use in forex trading. Nowadays many forex traders are complex between the choosing of the perfect and best forex indicator for better trade. But as usual, they always fail as there are many overrated trading tools and indicators in the market who never show the original results of the indicators. Often novice traders stick in the matter of the free and paid results and sometimes fail to take the right decision in the forex trading from the tools they have. 

>> Here is the list of the best MT5 support and resistance indicators that can help you to trade on an international forex market in a better way.

Final notes

One key observation of price action traders is that the market often revisits price levels where it reversed or consolidated. If the market reverses at a certain level, then on returning to that level, the price action trader expects the market to either carry on past the reversal point or to reverse again.  The trader takes no action until the market has done one or the other. It often brings higher probability trade entries, once this point has passed and the market is either continuing or reversing again.

Price action traders do not take the first opportunity but rather wait for a second entry to make their trade. For instance, the second attempt by bears to force the market down to new lows represents, if it fails, a double bottom and the point at which many bears will abandon their bearish opinions and start buying, joining the bulls and generating a strong move upwards. Also as an example, after a break-out of a trading range or a trend line, the market may return to the level of the break-out and then instead of rejoining the trading range or the trend, will reverse and continue the break-out. This is also known as ‘confirmation’. Price action traders often use this second touch as their entry point for a trade.

Understand how support and resistance levels work in trading is important, but if you need some help MetaTrader 5 AM Broker provides some advanced support and resistance indicators and analytic tools. 

Test the signals of support and resistance indicators with an Expert Advisor Builder that generates backtested Forex EAs or Forex Robots with a few clicks.

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