In commodities and securities trading, technical analysts use support and resistance price levels to determine points on a chart where the price from could change direction. It is important to identify a support or resistance zones because it provides potential trade entry or exit points. Traders can bet on a price direction based on whether the price stays within or breaks through the support or resistance zones. If the price moves in the anticipated direction then traders can make a substantial profit. But if the price moves in the wrong direction, traders can immediately close their position and minimize losses.
What are Support and Resistance Price Levels?
Support is a price level in which a temporary stop in a downtrend can be expected because of higher demand. It can also be regarded as a floor that prevents prices from being pushed downward. Identifying a support level represents a good buying opportunity because it reflects when traders and investors might see good value which can push prices higher again. The support level also represents a point when a commodity or financial instrument can experience increased demand or buying pressure.
On the other hand, resistance is a price level in which a temporary stop in an uptrend is expected because of higher supply. It can also be considered as a ceiling because this level prevents prices from being pushed upward. Resistance levels signal a point where a commodity or financial instrument can experience increased selling pressure or a high number of sell orders.
Different Types of Support and Resistance Levels
There are different types or methods for identifying support and resistance zones. These include trend lines, round numbers, moving averages, Fibonacci lines, chart patterns, pivot points and Gann lines.
- Trendline is basically a line under pivot lows and (over pivot highs in a trend channel) to show prevailing price direction. It is a visual representation of support and resistance and can be used to create a channel. Many technical analysts believe that identifying a trendline is an important step in making a good trade.
- Round numbers often act as both support and resistance because they can represent a high number of pending buy and sell orders. These numbers tend to act as a strong price barrier because most target prices or stop orders are set at round price levels. Round numbers also represent psychological turning points where traders make their buy or sell decisions.
- Moving averages are a popular technical analysis tool used by traders because it often creates dynamic support and resistance levels. It smooths out price data by creating a regularly updated price average. This average is taken over a specific period. Most traders experiment with different periods to determine the one that works best for them.
- Fibonacci lines or numbers are used to create technical indicators using a mathematical sequence that can be broken down into ratios to predict price movement. Two common Fibonacci tools are extensions and retracements which can be used to determine price reversals during market corrections. Fibonacci levels can act both as a support and resistance price.
- Chart patterns as distinctive formations created by price movements that are useful in identifying support and resistance levels. A pattern is formed by connecting common price points during a specific period of time. There are two different types of patterns. The continuation patterns which are used to identify opportunities to continue a trade and the reversal patterns which are used to determine opportunities to stop a trade.
- Pivot points are simply the average of high, low and closing prices on a particular trading day. They are used to determine the overall market trend in different time periods and also include support and resistance levels determined based on the calculation of the pivot points.
- Gann lines are used for predicting price movements based on analysis of the relations of geometric angles in charts that depict both time and price. There are nine angles for identifying trends and market actions. When one of these lines is broken, the following angle will provide support or resistance level.
How Traders Evaluate the Significance of Support and Resistance Zones
Support and resistance zones become more significant if the level has been tested many times over an extended period of time and when they are preceded by steep declines or advances. The zones are also likely to be stronger when more buying and selling occurs at a particular price level. Regardless of the method used for identifying the support and resistance zones, it will always be done with the view that the price level restricts price movement in a certain direction. It is also worth noting that psychology plays a major in the prediction of future price movements and ties into support and resistance levels.