Support and resistance levels explained – how to use them

• Support and resistance levels play a vital role in technical analysis, guiding traders in predicting potential price movements based on supply and demand dynamics.
• Support levels are the price points where the downward trend typically pauses as buyers step in, while resistance levels indicate an area where upward trends often pause as sellers take control.
• To identify these levels, traders analyse past price movements and monitor current price behaviour as they approach these key levels.
• Major support and resistance levels tend to be more significant, representing historical trend reversals, whereas minor support and resistance levels are often viewed as less dependable.
• The psychology behind these levels sheds light on how various types of traders could respond to price changes, ultimately affecting overall market behaviour.
• Understanding how market participants react at these levels could enhance a trader’s ability to make more informed trading decisions regarding entry and exit points.

Support and resistance levels can be found on different timeframes, such as the four-hour, one-hour, daily, weekly, and monthly charts, as well as shorter intervals like the one-minute or five-minute charts. These levels are established when price action reverses, creating notable highs and lows.

Generally speaking, the longer the time frame, the more essential the support and resistance levels are.

Traders could identify these levels by looking at historical price movements to find points during price increases or decreases where there was a notable pause. 

They could then look at the present price data to see how it reacts when it approaches one of these levels—whether it reverses or breaks through—providing valuable insights into making more informed trading decisions.

What is support?

When the market is in a downtrend, prices fall because there is more supply than demand. As prices drop, they start looking more attractive to potential buyers. Eventually, demand increases to match the supply, which helps stabilise the price.

When looking at the charts, support can be identified as a specific price level or a wider price zone, which is an area of interest for buyers looking to open long (buy) positions.

So, when the price reaches this level of support, there is generally an increase in buyer activity as more buyers come in (demand overwhelming supply). This results in the price struggling to move lower past the support level and reversing to the upside.

What is resistance?

Resistance is the opposite of supply. When the price is in an uptrend, there is more demand than supply due to buying pressure.

However, the price will reach a point where demand starts to decrease and supply increases, with sellers starting to seize their opportunity in the market. 

Now, this change could be due to various reasons, such as traders believing prices are too high and they’re not willing to take a chance on opening new positions or because it reached their profit targets.

When looking at the charts, the level where supply starts outweighing demand is what we call a resistance level. And like support, this can be a specific price level or a broader price zone.

There are two different types of support and resistance levels, namely major and minor support and resistance levels.

Minor support and resistance levels are generally less dependable. For example, during an uptrend, the price might hit a high, bounce for a short time, and continue to rise. This high could be seen as a minor resistance since the price paused at that level. 

However, due to the prevailing uptrend, the price is likely to break through this minor resistance without much opposition eventually.

Minor support and resistance zones could provide useful analytical insights. If the price falls below a minor support line, it could confirm that the prevailing downtrend is likely to continue. However, if the price pauses and then rises back to the prior low, it could indicate the beginning of a trading range.

Major support and resistance levels could be seen as more essential because they reflect price points that have historically resulted in trend reversals. 

For example, the level at which a price reversal from an uptrend to a downtrend occurred multiple times creates a strong resistance level, and the level at which the price reverses from a downtrend to an uptrend multiple times suggests a strong support level.

Prices frequently find it difficult to break through when they return to major support or resistance levels.

The price typically rises again as it approaches a major support level or falls when it approaches a major resistance level. The power of these essential price levels is highlighted because, although it might break through at some point, it usually reverses from that level several times first.

Traders could use a couple of methods to spot support and resistance levels. In addition to spotting these levels, traders could then also look for potential entry points and where to place stop-loss and take-profit orders. 

Below is a breakdown of three different processes for finding these levels.

Looking at historical price data

Traders could examine historical price data, which might be considered the most reliable way to identify potential future support and resistance levels. A thorough understanding of these past price movements could assist traders in not only identifying potential support and resistance levels but also in making more informed trading decisions.

Nonetheless, it might be essential to remember that historical levels could emerge under different market conditions. Thus, depending solely on past price movements might not always lead to accurate forecasts. Traders might want to consider a broader context when trying to identify these levels.

Looking at previous support and resistance levels

Using historical support and resistance levels could be an essential tool for determining possible entry and exit points. Traders could also potentially use these historical levels to forecast future price fluctuations.

That said, it might be essential to realise that these past support and resistance levels aren’t fixed, as markets rarely hit and reverse at the exact levels. Instead, considering these levels as zones instead of exact price points might be more beneficial. 

Maintaining this mindset might allow for a more adaptable approach when examining past market behaviour.

Using round numbers

Another way for traders to potentially spot support and resistance levels is by looking at round numbers, which can occur in almost all markets, such as the commodity, stock, and forex markets, appearing at price levels such as $100, $150, 1.1300, or 140.00.

Traders tend to focus on these round numbers because they believe an asset will have a difficult time moving past them. This behaviour is particularly noticeable among novice traders, who tend to make trading decisions based on these round numbers.

Instead of more precise values like $50.06 or 1.1205, several orders, including target prices and stop orders, are usually placed at these round price levels. Since so many orders are placed at the same level, these round numbers often serve as a strong price barrier.

For example, it would take an excessive number of purchases to absorb the sales if every client of an investment bank placed sell orders at the recommended goal of $100 or if big financial institutions placed large sell orders on a currency pair at a price level of 1.1600. As a result, a level of resistance would be established.

Using technical indicators

Technical analysis indicators (Fibonacci retracement or moving averages) and/or trendlines – which we’ll cover in more detail later in this article – could create dynamic support and resistance levels that adjust as the market moves. 

These levels vary across different markets and are influenced by various distinct factors, so it might take some time to develop the ability to identify which levels affect a market’s price.

Depending on their strategy and the market conditions at the time of analysis, traders could use these indicators either alone or to confirm support and resistance levels further.

Traders could also study historical price charts to develop and improve their ability to identify support and resistance levels. This practical method could also improve their comprehension and application of these levels in real-time trading situations.

If you want to draw support and resistance levels, you could find them using the following methods:

• Uptrends
• Downtrends
• Sideways trends
• Multiple timeframes
• Moving averages
• Fibonacci retracement tools
• Round numbers

Below, we’ll cover these methods in more detail.

Uptrends

For a market to be considered in an uptrend, the price has to make consecutive higher highs and higher lows. In order to find support and resistance levels, a trader could look at the sequence of highs and lows, connecting at least three higher lows for it to be a valid support level and connecting at least three higher highs for it to be considered a valid resistance level.

That said, many experienced traders won’t necessarily focus on the resistance level when the market uptrends. They tend to focus only on the support level and use that as an indicator for possible entry points.

Downtrends

For a market to be considered in a downtrend, the price has to make consecutive lower highs and lower lows. To find support and resistance levels, traders could also look for the sequence of highs and lows, like with an uptrend, and also look for at least three touchpoints.

In other words, at least three lower highs will be connected with a resistance level and three lower lows with a support level. Again, most traders might only focus on the resistance level to look for possible entry points.

Now, it might be worth noting that both the support and resistance levels could be seen as zones instead of an exact price point because the price might break through the support level when the market is in an uptrend, only to move back towards the prevailing trend shortly afterwards. 

When the market is in a downtrend, it might break through the resistance level only to move back down shortly afterwards. This is known as a fake-out or false breakout.

There is also the possibility of the price not touching the support or resistance level before moving back down when the market is in a downtrend or back up when it’s in an uptrend.

Additionally, if the price breaks through the support level with enough momentum, it could indicate that the market is about to move into a downtrend. 

Conversely, if the price breaks through the resistance level with enough momentum, it could suggest that the market is about to move towards an uptrend. 

Now, it might be worth mentioning that sometimes the price will break through and retest the level before continuing with the new trend, and other times, it will break through without retesting the level and move in the direction of the new trend.

In this instance, traders could wait for the higher highs and higher lows or lower highs and lower lows to form, depending on the new trend direction, before drawing up their new support and resistance levels.

Sideways trends

When the market moves into a sideways trend—also known as range-bound—it will make a sequence of almost equal highs and lows, where the price fails to break above previous highs or below previous lows. 

A trader could connect all the previous high points to draw a resistance level and all the previous low points to draw a support level, using both these levels to look for potential entry and exit points.

The same principle applies in a sideways trend as when the market is in an up or downtrend: The support and resistance levels could be seen as zones rather than specific price points because the price could break through (fake out) or not even touch either of these levels before reversing shortly afterwards, as seen in the picture below.

If the price does break through either to the up or downside and moves back to retest that specific level, the level of support becomes future resistance, and the level of resistance becomes future support.

Multiple timeframes

Traders could also use multiple timeframes when drawing support and resistance levels, starting on a higher timeframe and moving towards a lower timeframe to see whether those levels match up. This will also depend on which timeframes those traders generally use to trade on.

So, they could, for example, start on the four-hour timeframe and draw up these levels before moving towards the one-hour to see whether they match up and then move towards the 15-minute to see if they match up even further and also to look for possible entry points.

It might be worth noting that if the levels from the higher timeframes match up with the lower timeframes, they could be considered strong support and resistance levels.

Moving averages

By implementing the moving average indicator—either the 20-day or 50-day moving average—traders could look for possible support and resistance levels depending on the direction the price moves when their analysis is performed. 

When the MA is used to plot these levels, it is often referred to as dynamic support and resistance. This is because it continuously moves and adapts in response to price fluctuations, reflecting the market’s evolving trends.

If the price is in an uptrend, the moving average will be below the price, so it could be used as a support level, looking for possible entry points when the price moves down and retests the moving average. 

The opposite is true when the price is in a downtrend; the moving average will be above the price, so it could be used as a resistance level, looking for possible entry points when the price moves up and retests the moving average.

Again, there might be times when the price retraces, moves past or doesn’t even touch the moving average before continuing in the current trend. For this reason, it might be helpful to see these levels as zones rather than specific price points.

Fibonacci retracement tool

The Fibonacci retracement tool is generally used to look for possible entry points from price retracements by connecting the highest point in price to the lowest point in price when the market is in a downtrend and the lowest point to the highest point when it’s in an uptrend.

The premise works by examining the price’s retracement into the Fibonacci golden ratio zone at levels 61.8%, 50%, 38.2%, and 23.6%, looking for possible entry points at these levels.

The golden ratio levels within the Fibonacci retracement tool could also be used as support levels when the market is in an uptrend and resistance levels when it’s in a downtrend.

Now that we’ve covered how to draw support and resistance levels, we’ll examine different ways traders could trade these levels.

Range trading

When the market is range-bound or sideways trending, traders could look for possible entry and exit opportunities from the drawn-up support resistance levels we covered in the section about sideways trending markets.

The basic idea behind trading a ranging market strategy is that the price will face opposition at either support or resistance levels, bounce off those levels, and reverse. 

Traders could look for optimal entry points to place a long (buy) position once the price reaches the support level, placing a stop-loss order below the support level and a potential take-profit at resistance.

For a short (sell) position, traders could wait for the price to reach the resistance level, placing a stop-loss order above the resistance level and a potential take-profit target at support.

As we mentioned earlier, it might be better to think of these levels as zones rather than specific price points because the price could temporarily break through or not even touch these levels before reversing. 

That said, traders could incorporate other technical analysis factors, such as candlestick patterns or indicators, to further confirm their entry and exit points.

The ADX indicator could be used to confirm whether the market is ranging by looking for a reading below 25. Other indicators could include the RSI (Relative Strength Index) or Stochastic oscillator to determine whether the price is considered overbought or oversold.

Breakout trading

A breakout trading strategy could be implemented in any of the three market conditions: up, down, or sideways. The premise behind this strategy is waiting for the price to break out of either support or resistance and placing positions accordingly.

Although support and resistance levels are fundamental ideas in trading, the price isn’t going to travel between these two levels forever; it can break out of them at any time during a trading session. 

That said, these breakouts generally occur after a prolonged period of consolidation.

Typically, a breakout signals the beginning of a new trend, which means if a trader enters their position early enough, they could ride out the entire trend. When the price breaks out of a support level, it could indicate that a new possible downtrend is now in place, which could prompt traders to enter a short (sell) position and place a stop-loss order above the breakout candle.

Alternatively, if the price breaks out of a resistance level, it could indicate that a new possible uptrend is now in place, prompting traders to enter a long (buy) position and place a stop-loss order below the breakout candle.

The actual placement of the stop-loss and potential take-profit orders in the examples above might differ depending on a trader’s risk-to-reward ratio.

Something traders might want to keep in mind, which we touched on earlier in this article, is the possibility of fake breakouts, where the price briefly crosses a support or resistance level only to return to its previous range shortly afterwards. 

To possibly lower this risk, traders could use momentum indicators like the MACD (Moving Average Convergence Divergence) to confirm breakouts. 

A legitimate breakout is usually indicated by a significant price movement with high momentum, whereas a breakout with weak momentum may suggest a misleading signal.

Understanding these dynamics, using the types of indicators mentioned, and carefully examining price fluctuations could assist traders in their overall decision-making process. It might also be worth noting that before placing an order, traders might want to confirm whether the breakout is legitimate and consider the broader market environment.

Trendline trading

There are two different ways traders could go about trading trendlines: trading the pullback from the trendline and trading the reversal once the price breaks the trendline.

To explain this in more detail, when the price is in a downtrend connected with a resistance level, traders could wait for the price to retrace back towards that level. 

Once the price has reached the resistance level, they could open a short (sell) position, with a potential stop-loss order above the resistance level and a potential take-profit order below the previous low.

Conversely, when the price is in an uptrend connected with a support level, traders could wait for the price to retrace back towards that level. Once the price has reached the support level, they could open a long (buy) position with a potential stop-loss order below the support level and a potential take-profit order above the previous high.

For further confirmation, this strategy can also incorporate different technical analysis factors, such as candlestick patterns or indicators, such as the MACD or the RSI.

With the MACD, traders could confirm whether the trend is upward or downward by looking at where the MACD and signal lines are in correlation to the zero line running across the indicator, as well as the histogram colour and bar strength. 

When implementing the RSI, traders could look at whether the RSI is considered overbought or oversold to provide a broader overview of whether the price might continue in the current trend or reverse.

Moving average trading

We’ve already examined how traders could plot possible support and resistance levels using the moving average indicator. Now, we’re going to break down how traders could use this indicator to look for potential entry and exit positions in the market.

First, we’ll look at when the market is in an uptrend, with the moving average situated below the price, which could be used as a support level. This works much the same as the upward trendline we covered in the previous section. 

However, as previously mentioned, the support and resistance levels could be seen as dynamic in both up and downtrends because it moves with the price.

To spot potential entry positions, traders could wait for the price to retrace towards the moving average (MA). Once it retests the MA, traders could open a long (buy) position, placing a stop-loss order below it.

Now, let’s say the trend is moving downward; the moving average will be above the price and act as a resistance level. This again works much the same as a downward trendline. 

Traders could wait for the price to retrace towards the MA. Once the price retests the resistance level, they could then open a short (sell) position, placing a stop-loss order above the MA.

Now, it might be essential to remember that the exact placement of the stop-loss and take-profit orders is subject to change depending on a trader’s trading and risk management strategies.

It’s important to note that the price might not always touch or respect the moving average before reversing direction. Traders could enhance this strategy by using additional technical tools like candlestick patterns, the MACD, or the RSI. 

These could provide further confirmation when the price retraces toward the moving average, helping to assess whether the trend is likely to continue or reverse.

In any financial market, participants typically fall into one of three categories at a specific price level:

• Those with long positions.
• Those with short positions.
• Those who are still unsure about making a trade.

If the price rises from a support level and returns to it, long traders could consider adding to their positions. On the other hand, short sellers could start reconsidering their strategies and choose to close their positions at breakeven if the price moves back to the support level.

If the price returns to this level, traders who have yet to enter the market could also feel confident about going long. As these traders enter the market, the support level could be strengthened, increasing the likelihood of the price rebounding and rising.

However, the scenario shifts if the price breaks below the support level. Long traders may hold off and wait for the price to return to the previous support, which now acts as resistance, before closing their positions and possibly minimising losses. This might only be the case if they didn’t place a stop-loss order beforehand.

Short traders, on the other hand, might feel motivated to increase their positions if the price retests the new resistance level. Those who haven’t entered the market might also decide to go short in anticipation of a further price drop.

Understanding these reactions to support and resistance levels might be essential to assist traders in their overall market analysis. The behaviour of each group could sway market movements, offering insights into potential price shifts and helping traders make more informed decisions regarding entry and exit points.