If you pull up a plain chart of any currency pair on any timeframe and scrunch it up to make the bars or candles look really small to maximise the amount of information on the screen, you will see that price moves up and down, either in trends or in sideways channels reversing at highs and lows of price action.
All the price levels at which the candles or bars reverse at, whether they be at extremes of price action or at more minor levels causing just a temporary reverse in price movement, are levels of support and resistance.
In this article we are going to look at one of the most referenced and fundamental concepts in chart analysis – Support and resistance levels.
You will learn exactly what support and resistance levels are, how to draw meaningful levels on your charts and then how to use them successfully in your trading.
What are support and resistance levels?
Support and resistance levels are simply price levels on a chart which cause a price reaction or reversal. Resistance levels exist above price and support levels exist below price. Resistance levels provide a ceiling and resist the upward progression of price and support levels provide a support or floor and resist the falling of price through them.
Price never moves in a straight line.
It progresses in zigzag waves of upward and downwards movements, reversing at certain levels –
The higher the time frame, the more significant the reversal levels and hence the more significant the support or resistance level is that price reversed at.
We will look at drawing levels on a chart in a moment, but one of the key things to consider with support and resistance levels, is that they don’t just happen randomly in isolation.
They are generally levels on a chart where price has struggled or reversed at numerous times in the past. Therefore the higher the timeframe and the more often that price has reversed at certain key levels, the more significant and important these support and resistance levels become.
When we see price move to, and then reverse and move away from a level that it has reversed at numerous times in the past, we say that price has ‘respected’ that level of support or resistance.
If we deem the level to be significant, because it exists on a higher timeframe and has been respected numerous times in the past, we have a greater expectation that price will struggle to break through, or will reverse at this significant level the next time price revisits it.
Figure 1 above, shows a scrunched up daily chart of the Euro, displaying nearly 3 years of price information.
A series of blue horizontal lines have been drawn to show you the significant levels of support and resistance on the chart.
There are no labels to distract you.
Just run your eyes along each line and see how price, at different times in the past, has come back to ‘respect’ and reverse at these lines, but also breakthrough these lines at times when sufficient trend momentum existed.
As price progresses upwards through the levels of support and resistance, note how on the way back down, price reacts at the same levels.
Even in this basic chart, you can see that if price was to come near one of these lines in real time while you are trading, you might take a closer look at how price is travelling before making any concrete trading decisions…..and these are just lines on the Daily chart, there is much more going on in the lower timeframes as well.
See how the levels of support and resistance on this Daily chart provide locations where major market turns take place. This is why the higher the timeframe, the more significant the support and resistance levels become.
You will also see in this first example how price does not always stop dead at each of the lines, sometimes piercing the line before reversing.
You have to remember that trading and chart analysis is never perfect.
Each price bar or candle represents a unique event in the market, influenced by the numbers of buyers and sellers, plus the economic sentiment and worldview at that time. So with all these infinite variables, it’s incredible that price respects any historic levels at all, but it does and on every timeframe, for every instrument in every market.
As well as historical reaction/reversal levels acting as support and resistance, whole price numbers or ‘round numbers’ can also act as significant levels for buying and selling support and resistance.
This is particularly noticeable with the USDJPY and some other JPY cross pairs.
Have a look at the USDJPY daily chart below in figure 2.
The blue horizontal lines are drawn at whole number intervals, i.e. 110.0, 111.0, 112.0 etc.
Just take a moment to look at the chart and at the way price interacts with the round number levels.
Now look at the three upward pointing arrows pointing to the reactions at the 100.0 level.
The 100.0 level is not only a round number but a psychologically-important number too.
Can you see on the very left of the chart that price is falling quite dramatically and with quite some momentum into the 110.0 level, in fact the spike down preceding the first 110.0 touch reaches the 99.0 level exactly.
The first interaction with the 100.0 level was followed immediately by 2 weeks of hard buying, reversing at the 107.0 level, before falling even quicker back down to the 101.0 level and then back to the 100.0 level.
Price is driven up again to the 104.0 level before falling back to the 100.0 level for a 3rd time and then buyers finally take firm control and price storms up to the 118.0 level with the weakening JPY.
The blue window highlights the significance of the 118.0 level.
Here, over a period of almost 3 weeks, profit taking versus final retail buying battles it out before price prints a double top and selling steps in to take price back to the 108.0/109.0 levels.
Along the way, price oscillates between a series of round number levels.
Price then enters a longer period of broad sideways action, the high resistance level of 114.0 holding strong as the upper limit and the 108.0 level so far holding fast as the lower extreme of the channel.
It’s quite amazing to see this level of continuous interaction with a particular configuration of price number i.e. round numbers, which gives credibility to a trading system or strategy that uses them as profit targets or as stop level protection for these pairs that are particularly sensitive to them.
Now we have discussed what support and resistance levels are and how they form, let’s take a look in more detail at how price interacts with them.
Consider figure 3 below which is a magnified section of figure 1.
Price rallies with momentum into a level of resistance at point 1).
Even though price closes the other side of it, it gets rejected by sellers and profit takers at the level and the next bar reverses and closes back below. Upside momentum is obviously strong and the uptrend continues, breaking the resistance level again before falling to retest the level at point 2. Once the retest occurs, the level now becomes a level of support.
The pin bar that prints at point 2) is a sign of continued upward buying momentum and price quickly moves towards the next resistance level at point 3).
Here price finds more resistance than at point 1) and takes a few days of buying and selling juggling before price reverses and starts to fall away.
As it does so, it puts in a trailing spike back up to the resistance level, at point 4), confirming the level as resistance.
Price then reaches the new and recently retested level of support at point 5), this time spending more time at the level and giving further confidence in it’s validity and strength before the buyers step in again and price powers through the previously tested level of resistance at point 6), as it continues it’s upward journey with strength and momentum.
This is a great example of how support and resistance levels work and importantly, how they create swing highs and swing lows as part of a trend. Price is flowing upwards until it finds resistance and then finds the level of support below it, where continued buying pressure lies in wait for price to fall back to it.
When the trend comes to an end (in the blue window), you can see how the selling pressure at the level of resistance above price, is stronger than the level of buying pressure coming into it and as a result of that and of final profit taking from the buyers, price puts in a classic triple top or head and shoulders pattern with the neckline of the pattern being created by the support level below.
Finally price breaks short and closes below the neckline support level.
You can see how price then reverses off several support and resistance levels as it moves slowly away from the blue window.
Before we go any further, we’ll talk about how to draw support and resistance lines at the right levels.
Like most technical analysis, support and resistance lines can be very subjective and it takes time and practice to define the most appropriate levels and the right number of them. Too many and you will get too much interaction and confusion on your charts, not enough and you may miss some cracking trade opportunities.
Like all these things, it’s a bit of an art, but it’s not difficult to master if you practice it.
If you are marking up a chart with support and resistance lines for trading, then it is worthwhile considering what timeframes you are trading on and therefore which support and resistance lines are most appropriate.
For instance, if you are trading the hourly chart, then you might want to mark up the support and resistance lines on the Daily and 4 hour charts.
If you are trading the 5 minute charts, you will find the support and resistance lines on the hourly and 4 hourly charts sufficient.
If you are using 2 charts for support and resistance lines, it is worth using different line colours or line thicknesses to differentiate between the higher and lower timeframe levels. It is also worth noting that the higher time frame support and resistance levels will also represent main reversal / support and resistance levels on the lower timeframe as well.
1) Always start with the higher time frame
2) Scrunch the screen up to get the most data that is practical showing on your screen. The more data you use, the better the levels you will select. On the daily chart you want to get at least 3 years worth of data showing on the screen
3) Select the horizontal line tool and hold the mouse button down as you move the line up and down the screen until you find levels which are a best fit through a number of different reversal points. Alternatively, you can use the cross hair tool to just get used to looking at various levels and then drop a horizontal line in place.
4) Don’t worry if the points are not exact to start with, you can always fine tune the levels later.
5) When you have finished marking off the main lines on the daily, change the chart timeframe to the 4H and repeat the process in a different colour or line thickness to differentiate between the two timeframes. You only want to really get one or two H4 lines in between the daily lines (if at all), otherwise the chart will get too congested.
6) When you have finished adjusting your lines and are happy, drop down to the H1 trade chart timeframe and see how it all looks.
You will be amazed at the context the support and resistance lines give you.
7) Review and update your chart lines every weekend when you review the week ahead to make sure that all the lines are where they need to be.
8) Tip 1 – Save each pair as a separate template, so that if you mess your chart up or delete it by accident, you have a template to drop on a new one! This saves a lot of time and effort having to redo all the lines on both time frames again!
9) Tip 2 – If you are struggling to find the right lines to draw, switch to a line chart.
The line chart uses the closing prices instead of showing the highs and lows and therefore it can be easier to see the right levels to pick.
Figure 4 below shows the chart in figure 1 with both daily (blue) and H4 (red) support and resistance lines drawn. Figure 5 below shows the same chart but on the H1 timeframe and Figure 6 shows the chart in figure 1 with a line chart.
Now you have learnt what support and resistance levels are and also how to draw them, let’s have a quick look at some examples of how you might use them.
Figure 7 shows a section of the EURUSD chart used throughout this article, on the H1 trade timeframe with support and resistance lines drawn for both the Daily (blue) and H4 (red) timeframes.
There are a number of great examples to look at.
Circle 1 shows a classic support and resistance reversal at a Daily resistance level.
Once the reversal is confirmed by the bearish engulfing candle, you could enter a short trade with your stop placed above the high of the reversal, which is also has added protection from the Daily resistance level.
Your first target might be the next level of support, which happens to be the first red H4 level.
As price continues to fall, it breaks the level of support on the 3rd attempt and closes below it. Circles 2 and 3 show selling opportunities on the retest of the red broken support level, now turned resistance.
You would have to be quick to spot the first one.
Two very small bullish candles pull back to the now red resistance level and a large bearish engulfing candle leaves you in no doubt that the sellers are in control.
You could have either got in on the touch of the retest, or a safer trade would have been to enter on the close of the large bearish candle. Stop above the high of the candle and above the new level of resistance. Profit target would be the next level of support.
Circle 3 is another retest of the same level.
Again, your entry could be on the touch but better to wait for the confirmation, entering on the close of the bearish engulfing candle following the touch.
Again, stop above the high and above the level of resistance, profit target the next level of support.
Circle 2 is called a price retest, happening straight after the break of support and retesting the underside of the level, confirming the level as a new level of resistance.
Circle 3 is called a swing retest where price first falls to create a swing low and then retraces higher to create a swing high as it retests the level of resistance.
Circle 4 shows another swing high retest opportunity, similar to Circle 3 and Circle 5 shows a great example of a bounce/reversal trade opportunity at a significant daily support level. With the bounce trade, it is clear to see how much buying interest was waiting for price at the Daily support level.
The bullish reaction was immediate, creating a large bullish engulfing candle.
You could have entered long on the close of the bullish engulfing candle, placing your stop below the low of the reversal, and just beyond the Daily support level.
Profit target might have been the first H4 level of resistance or beyond.
Note how the two blue Daily support and resistance levels at the top and the bottom of the chart provide excellent, tradable reversals. On the H1 chart, the Daily support and resistance levels are very significant levels to watch.
In this article you have learnt what support and resistance levels are, why they form, how they are drawn, what happens at the levels as price interacts with them and also some ideas of how and when to use them. You have also seen how levels at round numbers with some currency pairs can also be used successfully as support and resistance.
You can see how drawing accurate levels on your charts enables you make clear observations and decisions about reversals and retests. It therefore pays to take the time to practice drawing these levels on your price charts so that you can hone your skills and use this relatively simple, but fundamental technique to your advantage.
Remember the tip about saving your marked up charts as templates as this makes life a lot easier if ever you delete a chart or erase levels by accident.
Mark up a few charts today and have a look at how price interacts with the levels you have just drawn. Remember, the lines you draw are just lines appearing on your screen, price does not need to respect them. However, drawn correctly and accurately, you will be pleasantly surprised at how price does actually interact with them, giving you yet another potentially profitable skill to benefit from.