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Support and resistance

Support and resistance lines are an important part of technical analysis. As prices are driven by excessive supply and demand, support and resistance levels establish where these market drivers meet on a trading chart. The troughs and peaks of trendlines are also known as support and resistance levels. The identification of these levels represents one of the most important skills in technical analysis.

Learn how to identify support and resistance levels on a price chart and learn some applied trading strategies for the financial markets. Our Next Generation trading platform comes with a range of technical analysis and drawing tools for this purpose, so get started by watching the video below.

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What is support and resistance in trading?

Support, as the name implies, indicates a price level or area on the trading chart under the current market price where buying interest is sufficiently strong enough to overcome selling pressure. As a result, a decline in price is halted and prices are turned back up again.

Resistance is the opposite of support. It represents a price level or area above the current market price where selling pressure may overcome buying pressure, causing the price to turn back down against an uptrend. It should be emphasised that an existing prior high does not imply that subsequent rallies will definitely fail at or below that high with pin-point accuracy, but rather that resistance could be anticipated in the general area.

GBP/USD support and resistance on an uptrend  |  GBP/JPY support and resistance on a downtrend

How to identify major support and resistance levels

Finding support and resistance levels involves determining what critical prices define the trend (or range) and are more important over and above other prices. There are guides and rules for determining the legitimacy and strength of a price level, irrespective of whether it is a support or resistance. These include:

  • Times tested: where a price level has been ‘tested’ (traded) at or near, several times, it may be remembered by participants. For example, traders may not sell into a low or trough if past experience has shown this is not wise.
  • Volume spent: following on from the above point, if large amounts of volume have been transacted at or near a certain level, this also tends to be considered and noted by participants in the market.
  • Recent trading: the more recent the trading at a certain level, the more relevant the level is to an analysis of market price.
  • Round numbers: for reasons more to do with psychology than anything else, traders (and people in general) tend to remember ‘round numbers’.

How to trade with support and resistance

One of the best uses of support and resistance is for defining entry and exit points for positions, coupled with efficient risk management settings. Some the practical uses of support and resistance include:

  • Take profit. This is the price at which one takes the profit available on a position. That is, as the price approaches a support (from above), short sellers may take profits on their positions. Conversely, as price approaches a resistance (from below), long traders may take profits.
  • Establish a new position near an unbroken level. When the price approaches the support level, a technically driven investor would tend to pitch limit buy orders near and above a defined support and, conversely, would pitch limit sell orders near and just under resistance levels.
  • Establish a new position on the break of a level. When a support breaks, one can initiate a short position on the technical expectation that prices will then go onto the next (lower) support level. Conversely, if a resistance breaks, one could buy on the expectation that prices will move on to the next (higher) resistance, if there is one.
  • Stop-loss setting​. A breach of a level can be used to limit loss too. Rather than using a break of a support or resistance level as an opportunity to establish a new position, you can also use it to minimise loss. A losing position should be immediately exited. The signal to do so comes from the breach of the support or resistance level.

Once broken, support and resistance levels reverse roles. This is a key aspect of support and resistance identification: once a level (whether support or resistance) is broken, the technical characteristic of the level is reversed. That is, a broken support now becomes a resistance and a broken resistance now becomes a support. Read more about how to deal with breakouts in the stock market.

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Support and resistance strategy

A simple support and resistance strategy involves one of the most useful technical patterns, which is a sideways trend, or range, as shown in the candlestick chart below.

The first step is to identify the support and resistance that bound the current and recently observed price action. Once this is done, the theory is to pitch the buy and sell orders appropriately, near and above the support and near and just under resistance levels. After this is done, it is prudent practice to apply stop losses (exit orders for example) to the buy (or sell) orders.

Example:

Below is a basic example of a trade plan with a planned limited risk (for example, the difference between our orders and the exit), for a hoped for return. If a trading plan is used and a sell position is entered into, one of two events will occur. They are outlined in the two figures below.

The first figure shows the ideal scenario. A short (sell) position was entered into at the top of the range, near the high and resistance level, with a stop loss on the other side of resistance. From the selling point, the price falls back to the lower end of the range and the take profit order (near support) is triggered and the position is exited with a profit.

The second figure shows the scenario to avoid, but that you must be prepared for. A short (sell) position was entered at the top of the range, near the high and resistance level, with a stop loss on the other side of resistance. From the selling point, the price rises back to, and through, the upper end of the range, instead of falling. In doing so, it hits and triggers the stop loss. This position is therefore exited with a loss.

What happens when the price goes down after short selling  |  What happens when the price goes up after short selling

Dynamic support and resistance levels

In the below example, a support has been broken and the price has dropped even lower. Over time, the price action has recovered to just below the old support, which is now expected to have reversed, to become a resistance level. This is what is called dynamic support and resistance levels, when they change to adapt to recent price action.

There are two options. The first is to short sell just below the resistance with a stop loss on the other side anticipating a drop in price. The second is to wait to see if there could be a technical breakout (where the price breaks the resistance) and a buy order can be entered just above the breach with a stop loss slightly below the old resistance (now expected to act as support).

How to draw support and resistance

Using our advanced Next Generation trading platform, you can add your own support and resistance levels through our range of drawing tools. Upon opening a price chart for the asset that you want to trade, click on the panel at the bottom of the screen called 'Draw Tools'. Here, you will have the ability to add lines of support and resistance, trendlines, channels, price tags and arrows to populate your charts with information. These technical analysis tools can be used on both desktop and mobile devices.

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Other patterns to look out for

The pattern below is known as a ‘double top’. It is a range pattern, where there are two distinct tests of resistance, which are then followed by a fall in price back down to the support level of the defined range, which is then breached. Note that the name of the pattern is not as important as the fact that a key identified level (in this case a support) was cut, or breached. There are elaborations of such patterns. If, for instance, there were three distinct tests of the topside (or resistance), followed by a price fall that actually breaks the support of the range, this would be called a ‘triple top’.

A trading pattern is ‘confirmed’ once the support or resistance levels are broken. Otherwise, it is only a probable or provisional pattern.

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Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

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