What are the support and resistance levels?
To understand the interest in technical support and resistance levels it is important to remember at all times that the markets react to the combined actions of buyers and sellers. It is the confrontation of purchases and sales that enable the establishment of the prices, or the rates of the assets concerned.
- The support level: A support level can be described as a threshold from which rising movements brake the fall in the price. This threshold is actually considered by buyers as an interesting entry point onto the market. It therefore generally indicates a renewal in the rise.
- The resistance level: A resistance level is basically the exact opposite of a support level. It is therefore a threshold from which a falling movement brakes the rise of a price. This threshold is therefore considered as an interesting sell signal which often leads to a falling correction.
How to interpret support and resistance levels?
To interpret the phenomena of support and resistance you simply need to draw a line that links at least two or three points, this is called the ‘support line’ or ‘resistance line’. Of course, the more points that this line links, the more reliable it is.
Moreover, when a straight line is attained after a number of tries this indicates a strong probability of a break in this line.
In fact, a straight line for the support or resistance level does not guarantee a result in the sense of a price correction. This simply means that the capacity for buyers or sellers has been compromised or a particular market condition has pushed the asset price to ‘break’ this straight line which provokes a new rise or fall towards a new support or resistance level.
Using the support and resistance levels in trading:
The support and resistance levels are necessary elements of technical analysis. They can be used in the following manner:
- An identified support level can serve as a buy signal if a rebound of the price is forecast. Of course, a break in the support level can also signify a good sell signal.
- A resistance level can be interpreted and used in the opposing manner. When an asset price approaches this threshold, this can be a good sell signal. But if the resistance level is broken it can then be identified as a buy signal.
Important Note: Although the support and resistance levels are good technical indicators for online trading, it is important to monitor other influential factors such as the trends or elements of fundamental analysis.
Let us use a simple example
On a candlestick chart for the daily rates of the pair EUR/USD we can see, as explained above, the two continuous horizontal lines at the top and bottom of the chart that give us the precise indications of the support and resistance levels.
For a support level at 1.5360 it is interesting to place for example a purchase order at this level. On the other hand, a sell order could be placed at 1.6000 as this is the resistance level.
The space between these two lines is called the ‘price channel’ or ‘trading channel’ and the rates of the asset observed moves for the most part inside this channel.
How do you use this information for trading?
As you have no doubt understood, it would be wise for you to establish a strategy for sales and purchases based mainly on the analysis of these two levels. However, you should not neglect other aspects including variables and non material influences such as the psychological aspects. It is therefore recommended to not base your entire strategy on these observations. These rates can actually break through the support levels as well as the resistance levels. All it takes to do so is an abrupt change in the anticipations of major investors in which case we see an acceleration of the trend.
Logically these great changes are provoked by an influential event in the news that is often easy to foresee by studying the economic calendar or following the advice given by us in the ‘news’ section.
These radical changes can however give you a valuable indication. In fact, they are often synonymous of a rising or falling tendency when either the resistance or support level is ‘broken’ through.
This explains why with certain charts the rates can sometimes go below the support or above the resistance. We call this a ‘breakthrough’ of the trend as it actually breaks through the support or resistance level.
We equally note that a breakout almost systematically entails new support and resistance levels which are re-evaluated according to the new market elements. Sometimes an inversion can be observed between the support level and the trend, one becomes the other and the same in reverse but this type of phenomenon is fairly rare.