Trading boils down to a simple question: At what price do I enter, and at what price do I exit? Sounds easy, but the actual execution can be complex. In this guide, I’ll show you how to identify and trade potential support and resistance levels effectively.
5 Ways How to Identify and Trade Support and Resistance Levels
1. Understanding Support and Resistance Levels
It’s here at support that price typically ends, and in some cases can reverse to the upside. Resistance is where price actually stops and can reverse to the downside. The thing is not to know just these levels, but how to act on them.
Lots of traders know about support and resistance, but not many understand how to trade them. You need to identify when they are likely going to hold or break in order to be a success.
2. Spotting Important Levels
More significant support and resistance levels that attract much attention from traders are more important. The concept is simple; the more people watching a level, the greater the chance it will be held or provoke a market response.
- Moving Averages: The daily chart moving averages, for example, 50-period and 200-period are watched by many traders. Widespread observation creates self-fulfilling prophecies—many traders act on the levels, creating strong reactions to it.
- Fibonacci Levels: The Fibonacci levels are popular, but they are subjective because many traders draw them differently. Therefore, they may not always act as strong support or resistance.
- Floor Trader Pivots: These levels are calculated from the previous day’s high, low, and close and are universally used across different time frames, making them very significant for all traders.
3. Determining If a Level Will Hold or Break
Not all support and resistance levels will hold. The difference lies in supply and demand and how money flows into the market. Here’s what to look for:
- If there is extreme buying pressure and very little selling into a resistance level, it will likely break.
- If there is strong buying interest at a support level, it will more likely hold.
This is where trading psychology and mass psychology kick in. As a result of how traders react in aggregate to a level, uncertainty grows and more reliable levels of support and resistance are found.
4. Tools to Analyze Money Flow
- Volume: Monitor the volume at price points. When high volume occurs during a move to a point of support or resistance, it is an indication that there is strong trader participation in the move.
- Time and Sales: This tool displays real-time trade information. Filtering for block trades aids in identifying the activities of professionals.
- Level 3 (Market Depth): Offers more insight than Level 2 as it shows order size and depth. However, ensure you’re watching professional trader activity, not just retail orders.
5. The Concept of “Resistance Becomes Support”
A classic trading pattern is when resistance turns into support after being breached. Here’s why:
- Demand Surge: When a resistance level is broken with good buying, it becomes a new support because those who have bought in take profits and could bring about price retracement.
- Volume Analysis: This pattern can be confirmed by volume. If the buying is persistent after the breach, then the level has a new role of becoming a support.
Key Insight: Trade this pattern only when the volume suggests sustained buying interest. Otherwise, the level might not hold.
Trading potential support and resistance requires a blend of mass psychology, technical analysis, and money flow indicators. Always check for confirmation with volume and order flow before making a trade. By understanding these dynamics, you’ll have a better chance of determining when levels will hold or break.
