In this piece, we delve into the mechanics of trading with Support and Resistance. Traders can utilize price action with support and resistance in the effort of taking a risk-efficient approach into markets. Price action is the permutation of technical analysis that involves stripping indicators from the charts in order to focus on the most important variable available to traders: While battles are waged within the spread on short-term variations, longer-term charts can display potential entry and exit points that can assist traders with strategy planning.
Given that markets are unpredictable, and also given that history often rhymes while it never perfectly repeats: Support and resistance are probably one of the most valuable tools available to traders, technical or otherwise. We previously looked at the necessity of risk management , and with support and resistance — traders can more adequately manage risk for their trading activities. But if the setup does work out and if support holds, traders can sit in a winning position and scale-out as prices move-up.
The key here is finding that area of support so that the stop can be properly placed. There are a plethora of ways to find support and resistance in a market, and we previously looked at a few of the more common in our Strategy Architecture series. Within the move, retracement levels are applied at pre-set intervals, and those intervals are based on the golden ratio of the Fibonacci sequence of: Some traders use slightly different retracements, choosing to use Chart prepared by James Stanley.
The reason for this is what we mentioned earlier: Inside the spread is chaos, and if we look at the way that price action moves during news announcements, with low levels of liquidity allowing prices to swing violently, this makes sense.
Trying to do so is usually a quick-way into the loss column, so traders will often evaluate support or resistance inflections with current price action in the effort of trading directional momentum in a market.
This was the top in May and again in July; but in each case, prices were on a bee-line higher until this resistance level came into play, at which point a rather extended reversal began to play out. Notice that price first resists at this level blue box , only for buyers to jump-back in after prices softened. Buyers re-gained control after a quick pullback green box , but on a subsequent re-test of that resistance, buyer motivation waned and sellers began to take-over red box.
For the trader that was buying on the first break of resistance at Even buyers looking to trade the subsequent resistance break probably ended up regretting it.
This capped gains in the pair until bears could take-over, and as we can see from the lower-low and lower-high showing after that second resistance inflection each in red , sellers began to take over after resistance failed to yield: The key variable in the above relationship was one of patience: To the trader quickly acting on the first test of resistance, they likely ended up in a losing trade.
As those four-hour candles closed with wicks around resistance, this opened the door for a short-side reversal setup so that the trader can look to place stops on the other side of resistance. This would allow for a relatively small risk outlay so that if resistance did end up breaking — the damage could be mitigated. But if that resistance did hold and if sellers were able to take control, the potential upside could be rather large compared to that initial risk outlay.
We discussed the various time frame relationships in the article, The Time Frames of Trading. Table prepared by James Stanley.
After traders have identified potential support and resistance levels and after the actionable time frames have been decided upon, traders can then look to confirm support and resistance by looking for reactions around these levels.
Candlestick wicks can be used to help highlight reactions. If prices temporarily dip below a support level, only for bidders to bring price back-above, then a wick will show through that price, and this is highlighting a potential reaction that can be used to trade that level. If we draw a Fibonacci retracement around the major-move that started in latter-July, the Prices moved all the way down to the The fact that buyers had responded in this region merely highlights the potential for support, with the possibility of a tight stop for continuation approaches.
But despite this lack of discernable direction on longer-term charts, the Fibonacci retracement produced from the above major move has helped to set support and resistance on the four-hour chart numerous times.
Notice how the apex of the reversal in the above chart shows right at the Each of these reactions can be actionable, in one way or another. Traders looking to trade a directional move can benefit greatly from support and resistance analysis, as it can allow the trader to buy uptrends at support or sell down-trends at resistance in a relatively risk-efficient manner. For up-trends, potential resistance can be used as profit targets, while support can be utilized for re-entry or stop placement.
For down-trends, potential support levels become targets while resistance can be used to add to the position or to set stops. We can even add support and resistance from other avenues, such as psychological levels or pivot points or even other Fibonacci retracements.
This can add significant texture to the chart to allow the trader to more efficiently manage their risk. After prices break below the purple zone, we have lower-lows and lower-highs. Traders, at that point, would likely want to move forward with a bearish side-bias in the effort of trading in the direction of the trend.
For each of these reactions, the candlestick wick showing sellers responding to resistance open the door for entries in the direction of the trend. Contact and follow James on Twitter: DailyFX provides forex news and technical analysis on the trends that influence the global currency markets. Click here to dismiss. Price action and Macro. Foundations of Technical Analysis: Classic Chart Patterns, Part I.
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