Support and resistance is a concept in technical analysis that the movement of a market price, will tend to stop and reverse direction at certain predetermined price levels.
A support level is a price level where the price tends to find support as it is going down. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely to continue dropping until it finds another support level.
A resistance level is the opposite of a support level. It is where the price tends to find resistance as it is going up. This means the price is more likely to “bounce” off this level rather than break through it. However, once the price has passed this level, by an amount exceeding some noise, it is likely that it will continue rising until it finds another resistance level.
Identifying support and resistance levels
The more often a support/resistance level is “tested” (touched and bounced off by price), the more significance given to that specific level.
If a price breaks past a support level, that support level often becomes a new resistance level. The opposite is true as well, if price breaks a resistance level, it will often find support at that level in the future.
In effect, support can become resistance and resistance can become support
Using support and resistance levels
This is an example of support switching roles with resistance, and vice versa:
If a market price is moving between support and resistance levels, then a basic investment strategy commonly used by investors, is to buy a CFD at support and sell at resistance, then short at resistance and cover the short at support as per the following example:
When predicting entry and exit investment timing, using support or resistance levels it is crucial to choose a chart based on a price interval period that aligns with your trading strategy timeframe. Short term traders tend to use charts based on interval periods, such as 1 minute, with longer term traders using price charts based on hourly, daily, weekly or monthly periods. Typically investors use shorter term interval charts when making a final decisions on when to invest, the chart below is based on each candlestick being 5mins of historical data. In this example the early signs that the price was coming out of a downtrend was when it started to form support at $1.6388 and then started to form higher highs and higher lows signaling a change from negative to positive trending.
This chart would be completely useless to a longer Term investor. It is always good to look over different timescales to see the overall underlying trend of the market.
Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument.