Those who are used to follow my market analysis hear this from me a lot that this support or resistance level is not strong enough, but this one is. What novice traders have a hard time to understand is that why a support or resistance level is weak and the other one is strong? What makes them weak or strong? This is what they ask me a lot.
Why a Support or Resistance Level Is Weak and the Other One Is Strong
Before I answer this question in more details, first I have to explain what do I mean by “level” and what is the difference of support/resistance levels and lines.
Support/resistance levels are horizontal lines that are plotted based on the peaks and valleys high and low prices:
Support/resistance lines are slant trendlines:
It is harder for novice traders to deal with support/resistance lines. They are more complicated and technical and it needs a lot more experience and knowledge to trade them. However, support/resistance levels are easier to understand, because they are simply plotted below the valleys’ low and peaks’ high prices. You don’t have to be too technical to do that.
The good thing is that the markets reaction to the support/resistance levels is usually stronger, more precise and less tricky.
In the last quiz, I showed you a screenshot with a support level breakout at left, and a resistance level breakout at right. Then I asked you which of the trade setups was stronger.
This question was based on the Stochastic Oscillator trading system. If you have not learned about it so far, you can do it now: Stochastic Oscillator
The above screenshot was chosen from the weekly chart of a currency pair that we don’t trade. I intentionally did it because I didn’t want you to have any mentality about it. It is USD/SGD weekly chart.
Unlike the other quizzes, I didn’t hide the price movement that was formed after the trade setups. So in this quiz you could easily see how each trade setup worked and made the price move. I didn’t care about the price movement after the trade setups. Indeed, in none of the trade setups I locate, I care about the next price movements, because it is what we never know.
We never know how the price moves after a trade setup. All we can do and we know how to do is (1) locating a too strong and valid trade setup, (2) choosing a proper position size based on the risk we want to take, and (3) taking the positions and setting the stop loss and target orders. We have no control on the other things including the next price movements.
Therefore, I never want you to guess how the price moves after a trade setup. This is not your job as a trader. Your job as a trader is to know whether the trade setup you locate is strong enough or not. You have to distinguish which party has taken the full control.
In the above screenshot, I wanted you to distinguish which trade setup was stronger. The strength of the above trade setups depends on the strength of the support or resistance levels that were broken. This is what I am going to explain in this post.
As you see on all charts, the price always goes up and down and makes a so many highs and lows or peaks and valleys. A strong peak or valley is the most visible one. It is the one which is more distinguishable from the others:
Now, if you refer to the above USD/SGD weekly chart, you can easily say which trade setup was stronger, because it formed after the breakout of a stronger support level. The left side support level looks much stronger. The right trade setup was formed after the breakout of a weak resistance level.
Although in both cases the price moved accordingly, this is what we never know. We can only see the trade setup and decide before the price movement.
The other difference of the first and second breakout is in the situation of Stochastic Oscillator. The first breakout formed when Stochastic Oscillator was in the oversold area. This is something that usually happens in a strong support/resistance breakout. The second breakout formed when Stochastic Oscillator had already left the overbought area and was placed below it.
So, Stochastic Oscillator can be a big help to distinguish whether the broken level is strong enough or not.
Our Next Quiz:
Below is the AUD/NZD weekly chart. Please explain whether the short trade setup formed by 2015.07.19 candlestick is strong enough or not. Please consider the 1.1302 resistance level, the bulls strength before the 2015.07.19 candlestick, Elliott Waves and also the monthly time frame situation.
I read all your comments but unfortunately I cannot add my comments to each of them. However, in addition to posting your own analysis, please read the others’ analysis and comment on them.
Trading the Support and Resistance Levels
Support and resistance breakout is the most reliable or at least one of the most reliable trading methods. The reason is that when a support or resistance is broken, it will work as a resistance or support, and so, it will make a barrier against the price that doesn’t let the price go against us and hit our stop loss. It means, our positions will have less risk if taken based on the support/resistance breakout, because the broken support or resistance will protect our stop loss.
Of course, it is always possible that the price breaks above or below the broken support/resistance during the retesting, and this is something that happens sometimes. In spite of this, still support/resistance breakout is more reliable, because you know that after the breakout there is a barrier in front of the price that resists and doesn’t let the price hit the SL in most cases.
The other thing is that with this system (support/resistance breakout), you have to make sure that you have plotted the support or resistance lines properly. Sometimes you think that you have found a good support/resistance line, and you wait for its breakout to take a position, but you don’t know that the line you have plotted is not correct. The more you practice and become more experienced in plotting the support/resistance lines, the higher number of reliable and true lines you will become able to plot, and so, your trading success rate goes higher.
We need to have at least two points to plot a support or resistance line:
Support and Resistance Levels:
Plotting the true and reliable support and resistance lines are a little technical and need more experience. However, there is an easier way to use the support and resistance to trade. You can trade the support and resistance “levels”.
Unlike the support and resistance lines (or trendlines), you do not need to have at least two points to locate a support or resistance level. In fact, each support or resistance level is simply a low or a high created through the price movement, in bearish, bullish or sideways markets:
As you see, there are so many support and resistance levels formed while the price moves and goes up and down. When the price goes up and then turns around, we will have a peak or resistance level (the small red horizontal lines). And when the price goes down and then turns around, we will have a valley or support level (the small green horizontal lines).
How Can We Trade Using the Support/Resistance Levels?
We can trade using the below facts:
1. To go up, the price has to break above the resistance level, otherwise it will stay below the resistance level, and will either form a range or will go down and form a downtrend. When we have a resistance level, we can go long if the price breaks above this level, because “usually” when the price breaks above a resistance level, it will go higher and will form another peak or resistance level which is higher than the previous one.
2. To go down, the price has to break below the support level, otherwise it will stay above the support level, and will either form a range or will go up and form an uptrend. When we have a support level, we can go short if the price breaks below this level, because “usually” when the price breaks below a support level, it will go lower and will form another valley or support level which is lower than the previous one.
We either have a trend or a sideways market. When the price keeps on breaking above the resistance levels, we have an uptrend. So we can set buy pending orders (buy stop) above the resistance levels, and go long each time the market breaks above a resistance level. The stop loss can be set several pips below the resistance level, because we expect the broken resistance level to work as a support and not to let the price go down. Therefore, we can place the stop loss several pips below the resistance level. The target can be at least twice of the stop loss size.
On the below screenshot, each yellow rectangle shows a buy stop order you could place while the market was going up. And of course, whenever the market formed a support level, you could place a sell pending order (sell limit) too (the blue rectangles), but when the market kept on going up and broke above the resistance level, you would have to delete the sell limit order and let the buy stop be triggered:
It is recommended to find the support and resistance levels, and set the pending orders based on the close price (line chart), but after that you can switch to the candlestick or bar chart that shows the high/low prices and wait for the orders to be triggered. On the above chart, if you switch to the candlestick chart after finding the peaks and valleys and setting the orders, you will see that the targets are triggered, and only in one case the target could not be triggered because the market reversed and the downtrend was started:
When the uptrend is finished and a downtrend is started, we can set the buy and sell pending orders, above the resistance and below the support levels. However, with the downtrends, only the sell pending orders will be triggered. The yellow rectangles show the sell pending orders that were triggered and the blue rectangles show the buy pending orders that had to be deleted and could not be triggered:
As you see, you will have a lot of trading opportunities with each trend.
When the market is ranging and you can find visible and strong support and resistance levels for the range, you can set a buy limit order several pips above the support level, and a sell stop order several pips below the resistance level:
Ranging markets are somehow easier to trade, however, to find and verify a ranging market you can use moving averages. When the price crosses the moving averages, specially the 200SMA, we have a ranging market. This is how the above chart will look like if you add some moving averages to it. As you see, it can easily tell you that we have a ranging market:
You can use moving averages for the trending markets too, because this system is perfect to locate and verify the trends. You can use it to locate the trends, and while the trend is ongoing you can trade the support/resistance levels the way it is explained above. To have a higher success rate in support/resistance levels trading, learn the MA system and use it to locate the trends, and set your pending orders while the trends are strong and ongoing based on the MA situation on the charts.
This is how you can use the support and resistance levels to trade. It is much easier and more mechanical in comparison to support/resistance lines, but you have to keep in your mind that your stop loss will be triggered with any trading system, and there is no trader who can be a winner 100% of the times. Any trading system has a risk level, and the more you practice and gain experience, the higher success rate you will have.
Support and Resistance Breakout – Stop Loss and Take Profit Settings
Locating the support and resistance lines are the most important part of technical analysis. Support and resistance lines are the foundation of technical analysis. To trade based on the support and resistance breakout, first we have to locate the correct support and resistance lines, wait for the price to breakout out of them, and then take the proper position. We buy after a resistance breakout. We sell after a support breakout.
If you connect the most visible highs to each other, you will have a resistance line.
If you connect the most visible lows to each other, you will have a support line.
Most traders prefer to use the close price or line chart to plots the support and resistance lines. The reason is that the lines that are plotted based on the close price are more stable and valid and markets react to these lines more accurately. Therefore, to plot the lines based on the close price, you have to switch to line chart.
A resistance line will be known as a broken resistance line when the price goes above it. If a candle closes above the resistance line, then the resistance breakout will be stronger and more reliable. To be at the safe side, you can wait for a candle to close above the resistance line. Then you can go long with more peace of mind.
In this example (watch the video), first we plot the resistance line based on the high price.
As you see, the price has broken above the resistance line here, but it did not keep on going up, and it went down.
It went up strongly only when this candle closed above the resistance line. That’s why we recommended to wait for a candle to close above the resistance line to take a long position.
Now we try plotting the resistance line using the close price or line chart. We connect the most visible highs here. The difference is that using the close price to plot the lines will save us from losing money on false breakouts. You can use both methods at the same time and compare the result.
As you see, the price has broken above the resistance line here, but it did not keep on going up, and it went down.
After plotting a resistance line, we wait for a candle to close above it. We will buy when the candle is closed and the next candle is opened.
We set the stop loss several pips below the resistance line.
The target can be at least 2 or 3 times bigger than the stop loss size.
In the example, we have a 55 pips stop loss. And as you see the price goes up after the resistance breakout for over 220 pips. Therefore, our target could be easily triggered.
This is how we buy, after a resistance breakout.
It is the same with the support lines. First we plot the support line and wait for the breakout.
This support line is plotted based on the close price. This one is plotted based on the low price.
Then we wait for the support breakout. Here, this candle has closed below the support line. We could sell at the close of this candle, set the stop loss several pips above the high price of that candle, and set the target at least 2 to 3 times of the stop loss size.
You could use one of the support lines, either the one that was plotted based on the close price, or the one that was plotted based on the low price. Having both of them on the chart, helps you be more confident about the position you take.
This is another example of a support line, plotted based on the close price. This candle has closed below the support line, so that a support breakout formed.
We could take a short position at the close of this candle, and set the stop loss several pips above its open price.
A broken support line will work as a resistance line after the breakout. It means the line that was working as a support line, will work as a resistance line after the breakout. Therefore, sometimes after the breakout the price goes up to retest the broken support line as a resistance. As you see in this example, the next 2 candles that formed after the breakout candle, went up and retested the broken support line. However, the broken support line worked as a strong resistance and did not allow the price to break above it. So the next 2 candles closed below the broken support.
It is the same with the broken resistance lines too. A broken resistance line will work as a support. It means after the resistance breakout, the broken resistance works as a support.
After the resistance breakout, sometimes the price goes down to retest the broken resistance line. If the broken resistance line works as a strong support, it does not allow the price to go down and break below.
Therefore, the price will close above the broken resistance line and will go up after that.
Sometimes the price retests the broken line for a few times.
Some traders wait for the price to retest the broken line, before they take any position. The reason is that, retesting tells you if the broken line is a valid line, and the breakout is a reliable breakout. If the price can NOT break the broken line during the retesting, like what you see here in this example, it means the line and the breakout is valid, and we can take the position.
And, sometimes the price succeeds to break the broken line during the retesting. It means either the line is not a valid line, or the market condition is changed and the breakout is not valid anymore. In this case, we’d better not to enter the market, and wait for the next trade setup (of course if we have not entered already).
Here is the video: