Two common terms you’ll come across in trading - particularly in technical analysis - are the phrases ‘support’ and ‘resistance’ levels. But what do they mean and how do they apply to your trading?
In this lesson, you’ll learn:
- How to identify supports and resistance levels
- How to make a distinction between bounceback and breakthrough
- Why specific levels could provide interesting levels to enter the market
Two common terms you’ll come across in trading - particularly in technical analysis - are the phrases ‘support’ and ‘resistance’ levels. But what do these terms mean and how do they apply to your trading?
Support
A support level is found beneath the current price of an instrument and tends to be where falling prices find a floor of support. This means the price is more likely to ‘bounce’ off this level rather than break through it. For example, if you notice that a market has difficulties with breaking below a specific level, that means that you have identified a support. A general rule is that support levels tend to stop prices from falling any lower i.e. giving prices support. Support levels happen for a number of different reasons - essentially, they attract buyers back into the market as a psychological level ie. ‘The price of this market shouldn’t fall any lower, so I’m going to go long.’
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Resistance
A resistance level is found above the current price of an instrument, and acts as a ceiling for prices as they rise. The opposite of a support level, resistance levels mean that the price is more likely to fall back from this level than break through it. A general rule for resistance levels is that they tend to stop prices from increasing further and act like a price ceiling of resistance. Essentially, they encourage traders to lock in their positions and attract sellers back into the market ie. ‘I don’t think the market is going to go higher, so I’m going to close my position by selling.’
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How to identify support and resistance
There’s a wide range of tools and analytical methods that help in identifying levels of support and resistance, which include:
- Previous tops and bottoms
- Candlestick patterns
- Moving averages
- Trend lines
- Bollinger Bands
- Fibonacci retracement
Levels to watch
When support/resistance levels are broken, a breakthrough or bounceback typically takes place - until another support or resistance level is found. For example, EURUSD could find difficulties breaking above 1.15. It might test this barrier two or three times before bouncing back below, or it may eventually break through.
A bounceback is a situation when an asset rebounds from the level that was identified as a resistance or a support. Look at the chart below: it was difficult for oil WTI to break above $55 per barrel. The price rebounded a few times from the level and retreated later, sending the commodity $7 lower in a relatively short period of time.
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While a bounceback is more probable than a breakthrough, the latter would be a signal that the market may reverse trends at least in the short-term.
A breakthrough is an important moment in trading as it usually leads to a rapid increase in volatility. As shown on the chart below, the pair has struggled to break below 1.35, but after it eventually managed to, a rapid move occurred.
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Additionally, after a support level is broken it becomes a new level of resistance and when a resistance level is broken it becomes a level of support.
Look at the USDMXN. 20.00 was a crucial level that many traders looked at. After breaking above it, the pair rose 2 additional figures and reached historical high at 22.00. However, a decline has started since then. USDMXN broke below 20.00, retested it (a support converted to a resistance), failed to break higher and then continued its march lower. That’s a typical situation worth looking for, as it gives a lot of opportunities for traders to join the trend. In such a situation, a trader could have sold the pair after it re-tested 20.00.
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