Determining support and resistance

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Determining support and resistanceDetermining Support and Resistance

Support and resistance are used to identify key levels where the trend in price has a greater probability of halting and possibly changing direction. It can be a specific price, or price area. Interpretation of the degree of significance of a level depends on a trader’s time frame. It is best to use in conjunction with other indicators, such as moving averages, Fibonacci retracement ratios, and trendlines in order to support the price pattern. However, support/resistance areas can be traded based on price alone.

Support and Resistance Lines

A support level is where buyers step in and become more aggressive, therefore keeping price from going lower. As price declines towards support, selling pressure declines due to lower price, and buyers become more aggressive due to this lower price. A support level will eventually be broken and price will decline below it. That price will then become a future resistance level.

A resistance level is where sellers step in and become more aggressive and, therefore, keep prices from going higher. As price rallies towards resistance, buying pressure declines due to higher prices, and selling pressure increases. A resistance level will eventually be broken and price will rise above it. That price will then become a future support level.

Major and Minor Support and Resistance

There are many support and resistance levels in charts at every time frame that can be used to help a trader enter, exit or manage trades. Interpretation of the significance of support/resistance levels depends on the time frame for the trade, whether the trade is long or short, and how many periods the chart shows a specific price or area to be significant. It is important to determine which levels on specific time frames are most important to your trading strategy.

The longer the time frame, the more important the potential support/resistance level becomes. For example, identifying support/resistance on a weekly chart is going to be more significant than a daily chart, which will be more significant than an intraday chart. If you are a one to three week swing trader, there is probably not much significance to intraday support/resistance levels. Remember, interpretation is somewhat subjective and the behavior of price at these key levels will help determine the action a trader takes.

Major and minor support/resistance levels are determined by the number of indicators that support the interpretation of the levels.

Pivot Points

The pivot point is an ideal buy point. It is the point where price breaks through support or resistance and a trade should be initiated. At that point, the probability has increased that price will follow-through as anticipated.

Moving Averages

Moving averages are one of the most commonly used technical indicators. They smooth out price volatility and help recognize and confirm interpretation of price behavior. Moving averages are used to confirm or support interpretations of support/resistance levels, as well as identify key levels for trend continuations and reversals.

The most commonly used moving averages are simple and exponential:

Simple – Takes the closing price over a determined period of time and calculates a moving average with equal weight given to each price point. Provides a later signal than an exponential moving average.

Exponential - Takes the closing price over a determined period of time and calculates a moving average by giving greater weight to more current price points. Provides an earlier signal than a simple moving average.

As with all technical indicators, moving averages should be used in conjunction with other indicators, such as price. They are most useful in trending markets and can be used on all tradable financial instruments, including stocks and indices.

The most common time frames are 10, 20, 50, 100, and 200 period moving averages. The longer the time frame, the greater its potential significance. A 200 period moving average is going to have greater significance than a 10 period, and so on. It also follows that a signal from a 200 moving average on an intraday chart will be less significant than on a daily chart. Since markets are fractal (the same patterns reveal themselves at every time frame), moving averages can be used on any chart, no matter what the time frame.

To determine which period you should use, determine what time frame you are trying to trade - short, intermediate or long. Generally, short term is 25 periods or less, intermediate is 25 to 100, and long term is 100 to 200 periods.