How To Trade Reversals At Support And Resistance Levels
* Resistance levels show the previous highest price a pair has managed in a time frame
* Support levels show the previous lowest price a pair has managed in a time frame
* Going beyond resistance levels is called a breakout
* Going below support levels is called a bounce
Why Are Support And Resistance So Important In Forex?
This article explains how traders can find support and resistance levels on the price chart. Then it reviews how traders can use those support and resistance levels to their advantage.
Furthermore, it shows how to improve your trade setups at support and resistance levels. It also analyses how to avoid bad setups and trading ideas.
But first of all, we need to address the main question: why are support and resistance levels important in the first place? What is the meaning of support and resistance? Let’s start with support and resistance for beginners.
There are many good reasons for using support and resistance levels. Most traders will agree that they offer a lot of benefits. Let’s review some of them before discussing how to use support and resistance zones for determining decision zones.
Support and resistance levels are a critical part of technical and chart analysis because of these reasons at the very least:
* Bounce and breakout levels: the support and resistance levels are used to identify breakouts and bounces that have higher probability of success.
* Better trading ideas: traders can improve their setups if they focus on key decision zones and points of confluence.
* Time frames: the support and resistance levels can be found on all time frames. Traders can view multiple time frames to find key levels.
* Confluence: the more confluence of support and resistance levels, the more chance that price action will react in a big way to the zone (either via a breakout or bounce).
* Filter for avoiding trades: a trader might successfully be able to skip a trading idea that is getting very close to a strong support and resistance zone. Avoiding bad setups is just as valuable as good setups.
* Valid in all environments: support and resistance levels are always useful, whether price action is trending, retracing, or ranging.
* Useful for all trading styles: support and resistance levels offer benefits for a trading plan whether the trader is using price action, price indicators, or a combination of them.
* Useful for trading all time frames: it is also useful whether traders are trading short-term, scalping, intra-day swing setups, or long-term.
Most traders agree that support and resistance patterns are key and with good reason (see 8 points above). Now let’s review how to determine the decision zones using support and resistance.
Trading Support And Resistance: Determining Decision Zones
First of all, we need to determine how to find the strongest support and resistance zones. A support and resistance definition is a must. Let’s first explain the support and resistance basics for beginners:
* Tops and bottoms (blue and red boxes in the image below) are often key decision zones for price action. Price will either break through the support or resistance (S&R) zone or bounce at these levels for a breakout.
* Another way to determine decision zones or points of confluences (POC) is by using multiple tools and indicators that highlight the same price area (green boxes). For instance, a trend line, Fibonacci level, and a moving average close to the same price level indicate a stronger support or resistance level.
Usually speaking, when price action reaches a strong support or resistance zone in Forex for the first time, price action makes some type of bounce or reversal. Traders can try to benefit from this by catching setups at the support or resistance zone.
However, keep in mind that support and resistance levels can always break as well. The art is to find support and resistance zones that are strong, and hence have better odds of not breaking.
Plus if a support or resistance zone is tested for the second, third, fourth, or more times, then a breakout is also starting to become more and more likely. In these cases, it could make sense to skip reversal trade ideas.
These aspects could be useful for any support and resistance strategy or if traders are trading support and resistance zones.
Pros And Cons Of Trading Methods At Support And Resistance
Traders can trade support and resistance in Forex via two different approaches:
* Pending order at or close to the support and resistance zone (orange box).
* Market order after price action confirms a reaction at the support and resistance zone (purple box).
Both methods have their advantages (pros) and disadvantages (cons).
Let’s summarize the pros and cons for pending orders:
Pros Pending Orders:
* This order type provides the best entry possible because traders are entering as the price approaches the support or resistance level and bouncing spot.
* Pending orders can be deleted if the price action misses the entry at the first attempt.
* Once in a trade, traders can move their trade quicker to break even and remove the risk of that trade if the setup develops in their favor.
Cons Pending Orders:
* Price action can break through the pending order and support or resistance level.
* Trying to trade against the immediate momentum is risky as there is no guarantee that price action will stop at the support or resistance level.
* Price action can tag the stop loss level and then still revert into the anticipated direction but only after the trade closes for a loss.
Now let’s review the pros and cons of market orders:
Pros Market Orders:
* This entry type has more confirmation that price action is respecting the support or resistance zone because a candlestick has formed at or close to the support or resistance level.
* After the confirmation, traders can still try to get a better entry price level by using lower time frames.
* The price action offers a clear spot for placing a stop loss.
Cons Market Orders:
* The entry price is often worse than the pending order because the price has already moved partially into that direction which provided the confirmation.
* It takes longer before traders can move their trades to break even as the reaction at support and resistance needs to be more substantial (part of the price movement at the S&R level was needed to confirm the initial reaction).
Of course, it will depend on the support and resistance strategy or analysis of each trader. Also, it depends on their support and resistance Forex indicator of choice.
Pending Order Trading Methods At Support And Resistance
When trading via pending orders at the support and resistance zone, it is important to choose a proper stop loss level.
The stop loss level is preferably not too close to the entry. Why? Because S&R levels are a zone and not an exact level.
This means that price action does not have to stop exactly at 1.20 if the S&R zone is located at 1.20. It could also stop around this level and still qualify as a bounce at support or resistance.
Let’s review how it works with support: price action is falling down to 1.20.
* Price action hits 1.2005 and then reverses back up.
* Price action breaks shortly below 1.20 to 1.1995 and then bounces back up.
* In both cases, traders usually consider both scenarios to be a potential reversal.
The higher the time frame, the wider this S&R zone actually becomes. On a 5 minute chart, a zone of 10 pips is probably sufficient. But on a daily chart, a zone of pips is more applicable.
That is why using a too-tight stop loss level is risky. Because there is a higher chance that price could quickly tag it before moving into the anticipated direction.
Whether traders want to place a pending level right at the S&R zone or at a worse or better entry spot depends on their analysis:
* Is the support or resistance zone strong?
* Does the support or resistance offer confluence?
* Is this the first attempt to test the support or resistance zone in the past candles?
* Was there a moment in the past (more than 30 candles) that price action has bounced at this support or resistance zone?
If a trader likes this particular trade setup, they could opt to place the pending order closer to the price so they do not miss the setup.
If a trader thinks that this particular trade setup could be weaker, then they could opt to place the pending order further from price as a way to get a better entry price.
Market Order Trading Methods At Support And Resistance
When trading via market orders at the support and resistance zone (green box in the image below), it is important to wait for a clear and decisive price reaction (blue arrows in the image below).
Weak candlestick patterns could indicate that the reversal will fail. Whereas strong price action signals increase the chance of a larger reversal.
Strong candlestick reactions includes:
* Reversal candlestick patterns.
* Strong candle closes near the high for bullish reversals and near the low for bearish reversals.
* Larger sized candles (smaller candles could indicate weakness).
* Doji candlestick could indicate indecision.
If traders are unsure about a particular price reaction to a S&R zone, then they can also opt for a double confirmation (red boxes in image above).
They can wait for a breakout of the candle high or low instead of trading the candlestick pattern or confirmation:
* With a bullish reversal: a break of the candle highs could indicate a continuation.
* With a bearish reversal: a break of the candle lows could indicate a continuation.
If a strong price action signal arrives at or close the support and resistance zone, then using that candlestick for placing the stop loss usually works well.
Only in the case that the reaction is weak or a Doji (indecision), then it is better advised to a wider stop loss until a strong price action signal might allow a tighter stop loss.
What Did We Learn From This Article on S&R?
Support and resistance zones help traders understand the price charts and offer ways of analyzing and trading them. This article reviewed multiple aspects:
* How to find support and resistance zones and determine decision zones.
* Pros and cons of using pending orders or market orders at support and resistance levels.
* Trading methods for using pending orders at support and resistance levels.
* Trading methods for using market orders at or around support and resistance levels.
Common Questions On Support & Resistance Levels
Which Indicator Is Best For Support And Resistance?
There are tons of indicators that show support and resistance levels. What works best depends on the trader’s trading plan and system. For instance, an Elliott Wave trader will probably prefer using the Fibonacci tool and levels for finding support and resistance. A price indicator trader could prefer price bands, moving averages, or pivot points. And a price action only trader could simply rely on tops, bottoms, and round levels. That said, there are a couple of indicators that enjoy more popularity than the others. For instance, Fibonacci levels, tops and bottoms, and moving averages are probably widespread used among traders. This does not mean that other support and resistance levels are not important though. The most important is to use support and resistance indicators and tools that suit your trading plan and style.
How Do You Indicate Support And Resistance?
Support and resistance levels are either indicated by indicators or by manual tools and lines based on tops, bottoms, and other levels. Indicators usually show the support and resistance levels automatically. Tools and manually drawn lines need to be added by traders themselves. If the key level is below the price action, then this is considered a support level. If the key level is above the price action, then this is considered a resistance level. The same is valid for a house: the floor is support if you stand on it but resistance if it is above you. The same concept is valid for price action.
How Do I Add Support And Resistance In MT4?
Traders can add support and resistance Forex indicator in the MT4 platform by choosing the indicators that are already offered on the platform. When in MT4, click on insert, indicators, and then choose the indicator of your choice. Traders can also add Fibonacci levels, trend lines, horizontal levels, and custom indicators to the MT4. You will be surprised how many support and resistance MT5 indicators and support and resistance MT4 indicators you can find. Most MT4 and MT5 platforms offer moving averages, Fractals, trend lines, Ichimoku, Bollinger Bands envelopes, parabolic, alligator, Fibonacci retracements, Fibonacci extensions, shapes, arrows, boxes, horizontal lines, cycle lines, Andrew’s Pitchfork, trend channels, Gann lines, and more.