Technical analysis makes use of price and volume data to analyse markets, identify opportunities and manage risk.
Technical analysis makes use of price and volume data to analyse markets, identify opportunities and manage risk. The concepts of support, resistance and trends underly many of the strategies and tools used in technical analysis.
This is a brief introduction to the concepts of support, resistance and trends and how they can be used to analyse and trade any market. These principles apply to charts on all timeframes from one minute to weekly and even monthly charts.
What Are Support and Resistance Levels?
The prices of assets – be they currencies, stocks, commodities or any other tradeable asset – move when supply and demand are not in equilibrium. When demand is greater than supply, prices will rise until supply is equal to or greater than demand. When supply is greater than demand, prices will fall until demand is equal to or greater than supply.
A price at which the price stops moving higher is a resistance level. A price at which prices stop moving lower is a support level.
Horizontal Support and Resistance on a Bar Chart
What causes Support and Resistance to Form
Support and resistance usually exist at prices where it has occurred in the past, or where the market expects it to occur. Horizonal or lateral support or resistance occurs when the price stops moving higher or lower at the same price it has previously reversed direction. When a market is in equilibrium prices will often oscillate within a narrow range between horizontal support and resistance.
The following are some of the other areas that can act as support and resistance:
* Round numbers like 10, 50 or 100 will sometimes act as support or resistance simply because they are obvious prices.
* Major highs and lows also act as support and resistance, as do minor highs and lows, otherwise known as swing highs and lows.
* When prices retrace a previous up or down move by a certain amount, that level will often act as support or resistance. The 50%, 38.2% and 61.8% retracement levels are the most common levels that traders look for prices to form a retracement.
* Moving averages, especially widely followed moving averages like the 7, 15 and 50 period, will often act as support in an uptrend or resistance in a downtrend.
* Other indicators like Bollinger Bands or those that indicate overbought and oversold levels can act as support and resistance at times.
When the market is moving up or down, highs and lows will often line up along ’trendlines’, which then act as support or resistance.
A line chart with a moving average acting as resistance and a trendline providing support
When a price breaks major support or resistance level a trend can develop.
A downtrend occurs when a series of lower highs and lower lows develop. The lower highs act as resistance, while each new low breaks the support provided by the previous low.
A candlestick chart showing a downtrend formed by lower highs and lower lows
An uptrend occurs when a series of higher highs and higher lows develops. The higher lows act as support, while each new high breaks the resistance offered by the previous high. Sometimes a trendline can be drawn through some of the higher lows.
A candlestick chart showing an uptrend with a trend line connecting 3 higher lows
Identifying A New Trend
All trends eventually come to an end. There are several ways to identify the beginning of a new trend.
* Highs and lows can be used to identify a change of trend. A new uptrend can only be confirmed when there is a new higher high and a new higher low. A new downtrend is confirmed by a lower high and a lower low.
* Trendlines breaks are a very popular way of identifying a change of trend. However, the trend line should first be broken and then retested so that a new high or low forms – this can confirm the change of trend.
* Moving averages can be used in two ways:
* At the end of an uptrend, if the price breaks a moving average that was providing support, and the average begins to offer resistance, the trend is now down. The opposite applies to the end of a downtrend.
* Two moving averages of different lengths, 10 and 20 for example, can be used together. When the shorter average is above the longer average, the trend is up. When the shorter average crosses below the longer average the trend has changed from up to down.
Application of Support, Resistance and Trends
The concepts discussed here can be used to develop trading strategies, identify opportunities, set profit targets and manage risk. Further tutorials will cover specific methods you can used to apply these principles to your trading.