Support and Resistance Levels
This lesson explains why support and resistance levels form, how to identify levels of genuine significance, and the two disciplined approaches to trading around them.
Risk note: educational content only. This article is not financial advice, investment advice, or a recommendation to buy or sell any instrument. Trading leveraged products can result in losses greater than expected, and each reader should understand the risks before trading.
Support and resistance is generally the first technical concept a new participant encounters, and it is also the concept most often applied without rigour. Correctly identified, these levels provide structure to a chart and a basis for the placement of entries, stop-loss orders and targets. Incorrectly identified, they produce a chart covered in lines that can be used to justify any position. This lesson describes the mechanism by which a level forms, explains why levels should be drawn as zones, sets out criteria for selecting levels of significance and describes the approaches used to trade around them.
The origin of a support or resistance level
Support is a price area at which buying interest has previously been sufficient to halt a decline; resistance is a price area at which selling interest has previously been sufficient to halt an advance. A level carries no intrinsic property. It is significant because a sufficient number of participants previously acted at that price, whether by taking profit, closing losing positions or opening new ones, that the balance of order flow visibly changed.
Two factors sustain the level thereafter. Participants who transacted at the level retain a memory of it and may act there again, and new participants observing the same chart identify the same turning point and position accordingly. It follows that levels drawn at clear and widely visible turning points carry more weight than levels drawn at subtle ones, since the former are recognised by a larger proportion of the participants whose orders determine the price.
Representing levels as zones
Price rarely reverses at a precise figure. A reaction at a level typically occurs across a narrow band that encompasses the wicks and bodies of the candles that formed the turning point. Marking this band as a zone, rather than as a single horizontal line, represents the level more accurately and avoids the false precision that a single line implies.
The practical benefit of a zone is in order placement. A stop-loss order set a few pips beyond a single line is vulnerable to execution on a minor overshoot that does not invalidate the level. A stop-loss order placed beyond the outer boundary of the zone allows for this imprecision and is executed only when the price has moved decisively through the area of prior interest.
Criteria for a significant level
A small number of well-chosen levels is more useful than a large number of weak ones. A level merits inclusion on the chart if it is visible on a higher timeframe such as the daily or four-hour chart, if it produced a decisive reaction rather than a gradual drift, if it is recent enough to remain relevant to current participants, and if it has not already been tested repeatedly. Contrary to a common assumption, a level that has been tested many times is weakening rather than strengthening, since each test consumes the resting orders that gave it significance.
A related principle is that of polarity: a resistance level that has been broken frequently acts as support on a subsequent return, and a broken support level frequently acts as resistance. Participants who sold at the former resistance and were stopped out, together with those who did not participate in the breakout, provide buying interest on the return. If the significance of a level cannot be stated in these terms, the level should be removed from the chart.
- Visible on the daily or four-hour chart.
- Produced a decisive reaction rather than a gradual drift.
- Recent enough to remain in the memory of current participants.
- Not already tested repeatedly.
Trading around a level
Two disciplined approaches are available. The first is to wait for the price to reach the level and to demonstrate rejection, through a candlestick formation or a failure to close beyond the zone, before entering in the direction of the reversal. The second is to wait for a decisive break of the level, followed by a return to test it from the other side, and to enter in the direction of the break once the level has held in its new role.
Both approaches require patience, since the confirming behaviour may take several candles to develop and may not develop at all. The approach that does not perform reliably is to assume that a level will hold and to enter before the market has provided any evidence to that effect. This anticipatory approach places the entry at the point of maximum uncertainty and is a frequent source of loss for new participants.