Monday, August 13, 2018

How to Identify Support and Resistance

The most fundamental concept a beginning trader should learn after learning to read the chart is how to identify support and resistance. Every technical trader knows this and you also need to learn support and resistance if you want to become a consistently profitable trader. 
Learn how to identify support and resistance
                                                    click the photo above to enlarge

Support and Resistance might the simplest concept you will learn about technical analysis but I guarantee that If you master this concept alone you won't need any other tools in order to succeed in the Forex Market.

Before we start learning about support and resistance, I want to discuss first the Law of Supply and Demand. Every market from simple to complex, in order to be actively trading, should have supply and demand.

Law of Supply and Demand

In economics, when one commodity has a high supply and low demand; the price of that commodity will fall. While if that commodity has a high demand and low supply; the price will go higher. A good example of this is the Tulip Mania happened during the 1600s in the Netherlands. Tulip has a premium price before because it was rare in the country and it was made even pricier because of a virus called Mosaic which altered the flowers' petal to have a flame-like coloration making it more valuable; price went even higher. 

A bulb named Semper Augustus, well known for its beautiful flame-like white and red petals was sold for more than the cost of a mansion during that time. People went crazy trading their lands, their life savings, and anything of their possessions. Because of the high demand, big tulip buyers hoarded the market and filled-up their inventories. This has depleted the supply; the scarcity has increased and demand soared high. 

In January of 1637, the price rose 20 times higher than its previous price. However in February,  a month later, the price dove 20 times lower and went even further down. As the price went lower, people are selling their bulbs even with a loss. This has increased the supply but demand went down also. This is the first financial bubble recorded. I will be discussing more of this topic in the future.

One thing to keep in mind, if the supply is low and demand is high then there will be more buying. If the supply is high and demand is low then there will be more selling. How can we apply this concept in trading? Where can we identify the areas of high supply and low demand? 

Support and Resistance

Support is simply the area in the chart where there is a lot of buying while Resistance is the area where there is a lot of selling. Simply put it this way. Support = Buyers = Demand and Resistance = Sellers = Supply. Buyers support the price value while Sellers resist the price value. The higher the demand, the more buyers coming into the market while the higher the supply, the more sellers coming into the market.  Let's take a look at the chart below. This is the same chart above.

Support and resistance zoom in. Learn how to identify support and resistance

Click the photo above to enlarge

As you can see from the chart above, on the first two arrows on the left side of the chart. As the price reaches the area of resistance, the price had a hard time breaking out on that area (arrows pointing above at a horizontal line identifies the resistance area and arrows pointing down identifies the support area). As more buyers join in to move the price higher, sellers keep on coming in also and eventually, the sellers have overcome the buyers and the price went down. 

Because this is a bull market, buyers are more persistent and more powerful. The price has found a support area (see the two arrows pointing down after the first resistance area) where the price has stayed for just a few moments, indicating that the bulls are strong; the price went back to the resistance area where it finally broke out of that area and the resistance became a support. 

Always keep this in mind. When a price brokes out of a resistance area, that area will become a support in the future. The same principle applies to the support. As the price went higher again, it found another area of resistance. The buyers stayed there for a while trying to break out from that strong resistance. Then it went down and found a strong support (strong resistance can become a strong support in the future price). See the chart below.

a support and resistance line showing a pin bar pattern

Click the photo above to enlarge

I have encircled a candlestick on the chart above that shows a pin-bar or hammer. The tail on the pin-bar touches the area of the previous resistance. As the price went to that area, it immediately went back up closing to almost the same as the opening price. Indicating that, that area has become a strong support. Don't worry if you are just a beginner and don't know much about price patterns like the pin-bar I have mentioned above, I will be discussing more of this later after this topic.

As price goes higher and higher, it will always bump into another area of resistance and support. The same principle applies as price goes lower and lower. Always remember to identify these areas before you jump into trading. Mastering this fundamental concept of support and resistance will give you more edge and higher winning probability. I advise you to go to your chart and take a lot of time to master identifying the support and resistance areas.

If you are a beginning trader or new to this blog you may check out my other tutorials here.

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