Support and resistance levels are the two fundamental elements in everyone’s price action analysis. It doesn’t matter whether you are trading forex pairs or cryptocurrencies, the SR levels are the basics in technical analysis.
If you are looking for success on the forex and crypto markets, you should definitely learn to identify correct support and resistance on any price chart.
Support and resistance levels are regions of high supply and demand. When investors feel price is too high, they tend to sell the asset. That in turn makes the asset’s price drop. Thus, this level is known as the resistance level. In the resistance or supply area, the sellers dominate the buyers and are thus able to push prices lower.
Similarly, the support level is an area where there is demand for the asset. Thus, at a support level, you will find buyers more often dominate the sellers. As a result of the buyers’ dominance, the asset’s price tends to rise or appreciate.
How to identify support and resistance levels
There are many different ways to identify and draw support and resistance levels. Some traders use just a single price point as a resistance or a support level. While this might hold true in some cases, SR levels are better identified within a price range.
Similarly, some traders tend to use the high or low price or the open and closing price as the point of reference to plot support and resistance levels. While there isn't much difference in what price values you use, choosing the closing and opening prices gives you a better idea of the market.
This means that you will find price spiking below a support level only to close back higher or price spiking through a resistance level only to close below the resistance level or area.
The above USDCAD chart shows the support and resistance levels plotted based on past price action, you can see how price reacted to these levels.
Identifying the support and resistance levels requires you to analyse the price action on the chart. Always start by looking on the left side of the chart and identifying key pivot areas where price has reversed (you can either use the open/close prices or the high/low prices).
Once you have plotted a resistance and support area, the next step is to wait for price to rise to the resistance level or to the support level. From here, traders can either go long or short when price is at support or at resistance.
When a support or a resistance level is breached, you can expect the level to change. Thus, a broken support level can become resistance and a broken resistance level can become support. Price often retraces back to this level to test before continuing the trend.
Trading bounce of SR levels
As mentioned, there are two main ways to trade the support and resistance levels. The first is to use the bounce. In this strategy, traders wait for price to retest the identified support or resistance level and then go long or short from these levels.
This is usually easy to trade, but given that identifying SR levels can be subjective, there are times when price can invalidate and result in a losing trade. The best way to avoid this is to look for a newly created support or resistance level and trade the first bounce off it.
The above example shows trading the bounce on the Ethereum chart. The chart below shows that on the 1-hour time frame, support and resistance levels were established as shown by the dotted horizontal lines. After establishing these levels, we notice how price rallies to the upside.
The reversal near the resistance level eventually sees prices falling back to the support. The chart also highlights an important aspect. Support and resistance levels can be breached, and there is no guarantee that a support or a resistance level will hold. This holds true in any market that you trade.
Trading break of SR levels
Trading the break of support and resistance levels requires a bit more effort, and traders need to be patient. Sometimes, price can break a SR level only to reverse. This can be dangerous as the markets can trap the long positions on the breached resistance or short positions on a breached support and could lead to big losses.
The best approach is to wait for a support or resistance level to be breached and then buy on a dip or sell on a rally following the breach of the said levels. Typically, the breakout from the SR levels has to be followed by some strong selling or buying pressure.
The above Ethereum chart shows how a previously formed resistance level was broken and price declined to this level to establish support. Likewise, on the right side, you can see how price broke a support level and retested this level to form resistance.
Support and resistance levels are, as stated, one of the most important elements of technical analysis and price action trading. Regardless of the market, you must keep in mind, that market has a memory and it tends to respect important support/resistance levels. The big investors respect those levels, so you should also.
The odds that price will once again reverse off a support level or break past a resistance level can allow traders to position themselves accordingly.