What is Support and Resistance?
Actual support or resistance is prior lows and prior highs, a series of candlesticks like a base or consolidation and unfilled gaps between candlesticks. The only real support or resistance is price and the level of monetary commitment by traders at those prices.
Support or resistance is objective, not subjective like western bar analysis tools that use things like trading bands, envelopes or Fibonacci retracements or other subjective tools that traders may believe to be support or resistance.
Support and Resistance Analysis
The first area of supply (sellers) in any timeframe is the prior candlestick’s high. The first area of demand (buyers) in any timeframe is the prior candlestick’s low. The second point of supply or demand is the prior pivot point or a cluster of candlesticks that formed a base or congestion area if there is no recognizable pivot point (more on pivots later in this Wiki).
Support or resistance areas that have many overlapping opens and closes of candlestick highs and lows create a tight area of demand or supply areas. Whereas pivot points can leave a loose area of supply or demand that can be easily overcome by price.
The price must move deeply into support or resistance (demand or supply) to be meaningful enough to neutralize the power of these areas. When prices move deeply into support or resistance it absorbs the buying or selling pressure that was built up there. This allows the market to have less supply or demand to push through on any subsequent tests of the area.
All analysis of supply and demand should be done horizontally not diagonally like trend lines or moving averages. Trend lines and moving averages should only be used as an aid to help speed up your support and resistance analysis.
After a new move in price has broken through a supply or demand area a new area of demand or supply must be created in order to sustain that new move. Momentum moves indicate great strength or weakness, but if demand or supply does not create a new support or resistance area, there is nothing to stop a retracement in the opposite direction of the move should a retracement occur (see figure 5.1).
Figure 5.1: This graph shows new supply and demand areas being created throughout a trend.
V reversals or pivots are 1 to 3 bar reversal points within trends. They are places to focus your attention but the supply and demand are not overly significant. Multiple bar reversal points are very significant areas of supply or demand. Rounding tops or square formations that create bases or consolidations within a trend will usually be much more difficult areas of supply or demand to get through on subsequent tests by price at these levels.
Minor Price Support
Minor price support exists when a new low revisits a prior high (see figure 5.2). This concept of minor price support can offer some excellent entry points on the buy side and serves as a basis for increased trading accuracy with lower risk.
Minor support is a price level that lies just above the prior high in a steady uptrend. The basis for this support lies in the fact that resistance, once broken through to the upside, often becomes support. Each prior high in an uptrend is considered to be minor resistance. Once the stock or market breaks above its high, that high will often serve as minor support on subsequent pullbacks or dips. A ceiling once broken through to the upside becomes the floor. Old resistance becomes new support.
Minor support helps to identify when pullbacks in uptrends have good odds of halting or reversing. Combining buy patterns with minor support creates higher odds of successful trades. Fundamental Analysis Sentiment Analysis can aid in greater trading accuracy.
Basing or consolidating at minor support after breaking through prior resistance is a very strong indication that the prior uptrend will continue if it breaks to the upside again.
Figure 5.2: Uptrend, old resistance becomes new support.
Minor Price Resistance
Minor price resistance exists when a high revisits a prior low (see figure 5.3). This concept of minor price resistance can offer some excellent entry points on the selling short side and serves as a basis for increased trading accuracy and lower risk.
Minor resistance is a price level that lies just below the prior low in a steady downtrend. The basis for this resistance lies in the fact that support, once broken through to the downside, often becomes resistance. Each prior low in a downtrend is considered to be minor support. Once the stock or market breaks below its low, that low will often serve as minor resistance on subsequent rallies. A floor once broken through to the downside becomes the ceiling. Old support becomes new resistance.
Minor resistance helps to identify when rallies in downtrends have good odds of halting or reversing. Combining sell patterns with minor resistance creates higher odds of successful trades. Fundamental Analysis Sentiment Analysis can aid in greater trading accuracy.
Basing or consolidating at minor resistance after breaking through prior support is a very strong indication that the prior downtrend will continue if it breaks lower to the downside.
Figure 5.3: Downtrend, old support becomes new resistance.
Introduction to Major Support and Major Resistance
Major support or major resistance signifies that a stock or market is trading in stage 1 or stage 3. A trader who has mastered buy and sell patterns in these stages will be able to make profits when the rest of the market participants are losing money and getting chopped up in these sideways trading ranges. You know you are a true professional when you can make money in sideways markets where making money can be difficult.
Because the market spends a large portion of its time trapped in neutral sideways trading patterns, it’s essential that traders know how to handle these sideways trading ranges by using the concepts of major price support and major price resistance.
Major price support or resistance is never a single price point. It’s an area or zone, rather than an exact number, from where a rally or decline may begin or end.
Traders that had a profitable trading experience at the prior support or resistance area like to repeat their profitable actions if and when the price comes back to that area. There is a certain degree of memory held in support and resistance areas and this can sometimes help to create other major support or resistance areas.
Traders are full of expectations and the failure to exceed a prior support or resistance level will force them to change their expectations when they start losing money on their positions. These traders, therefore, exit their positions and add confirmation to the support or resistance areas with their liquidation orders. This is where great traders identify money-making opportunities and exploit them with the concepts of major support and major resistance.
Major support or resistance areas are sideways trends and all sideways trends will eventually breakout or breakdown.
Major Price Support
Major support can be defined as the current low revisiting a prior low. It can also be viewed as a double bottom (see figure 5.4).
Major price support is a price level or area at which the demand for a stock or market overwhelms the existing supply available. It is an area at which the buying begins to overwhelm the selling, the market turns from bearish to bullish.
Every low, from which a strong rally ensued, has contained within it a certain degree of positive memory. This is what can create something close to a self-fulfilling prophecy and makes for high odds of success buy scenario.
Traders who went short at the prior low expecting prices to breakdown and held on to their positions when the rally started are in pain and as soon as they get the chance to relieve themselves of their short position with a small loss or breakeven, they will do so. This will create demand at the prior low as traders want to get out of their short trades. Conversely, traders who bought and made a profit at the prior low will try to repeat their profitable actions at the low again. This adds more fuel to the rally. This is especially true if there was a lot of volume at the prior low as many traders are likely to be caught in a bad short position there.
Figure 5.4: Major support area.
Major Price Resistance
Major price resistance can be defined as the current high revisiting a prior high. It can also be viewed as a double top (see figure 5.5).
Major Price Resistance is a price level or area where the supply for a stock or market overwhelms the existing demand. It is an area where buying begins to overwhelm the selling and the market turns from bullish to bearish.
Every high from which a strong decline ensued has contained within it a certain degree of negative memory. This is what can create somewhat of a self-fulfilling prophecy and creates a high odds short trade scenario for traders who know how to take advantage of it.
Traders who went long at or near the prior high anticipating a breakout and held their positions when the decline started are in pain and as soon as they get a chance to relieve themselves of their positions with a small loss, they will do this as soon as the price gets close to where they bought. This will create overhanging supply at the prior high. Conversely, traders who shorted at the high and made a profit will try to repeat their profitable actions at that high again. This adds more fuel to the decline. This is especially true if there was a lot of volume at the prior high as many traders are likely to still be long there and want to get out.
Figure 5.5: Major resistance area
Supply and Demand Guidelines
Support can be viewed as demand. This is because it’s a more accurate representation of what is actually happening in the market. If a price area is to become support all that really means is that there is demand for the stock or market in that support area. This tells us that people want to buy and do so with real money to create that support area.
We view resistance as supply. This is an accurate representation of what is taking place in the market in those resistance areas. If a price area is to become resistance all that really means is that there is overhanging supply of inventory (the stock or market) that traders want to sell in that area. Real shares are sold and if there are more shares available for sale than there is demand to buy them, the price will drop as traders attempt to exit their positions or enter new shorts.
On each rally to resistance or decline to support the trader must assess the depth of penetration into that area of resistance or support. The deeper the level of penetration into that area, the greater the odds of overcoming that area the next time the price tests that level.
As prices move sideways away from prior supply or demand areas, those supply or demand areas become less significant on price retests. The longer the sideways movement, the larger the new area becomes in relation to prior supply or demand. It is up to the trader to assess which area is greater, prior supply or demand or the new area being created, and if prior supply or demand is more likely to hold or fail on future price tests. The size of the supply or demand area, and the distance between different supply and demand areas, will suggest the odds of overcoming the prior supply or demand area.
If a price breaks a supply (resistance) area overhead that is much greater than the demand (support) area below, the odds of a move lower are high. More sellers will step into the market because they see a good chance to get a decent price for the inventory they already own or they see a good opportunity to open a new short trade.
If the price breaks down through a demand (support) area that is much greater than the supply (resistance) area above, the odds of a move higher are likely. More buyers will step into the market as they see the price is on sale and is a good bargain.
Very loose supply or demand is made up of simple pivot highs and lows. There is not a tremendous amount of buying or selling at those levels to stop future price tests. However, there are different levels of pivot significance and we will discuss pivots in much detail later in this Wiki.
Tight supply or demand is made up of overlapping candlesticks and will form congestion areas, bases or holding patterns.
In a strong trend, minor or loose supply or demand points (pivots) will tend to hold on price retracements.
The depth of penetration into a supply or demand area will suggest the ability of prices to move through it on subsequent price tests.
Supply and demand is relevant in all timeframes. Traders should assess it in the larger timeframe and then trade it in the shorter timeframe for better entries and exits. There will always be more power to supply or demand areas in larger timeframes over smaller timeframes. For example, if you are a Day Trader the charts that you will likely use are the daily, 60, 15, and 5 minute charts. The daily chart will always show you greater supply or demand areas than the 60 minute. The 60 minute will have greater supply or demand areas than the 15 minute and so on.
If price builds a new area of supply or demand area while you are in a trade expecting your target to be reached, it can affect whether prices will be able to make it to your intended target. For example, if you are long and price rallies and forms a congestion area, then falls below it, there will be difficulty moving higher back through that newly formed area and you may not reach your price target.
The length of a base in relation to a prior area of supply or demand will suggest the probability of a larger movement after the breakout or breakdown. If the prior area of supply or demand is far away prices may have an easier time moving freely. This is called trading in a "Price Void". Trading within a price void, after pattern formations like bases, is a primary key to successful trades. You always want there to be a lot of room between supply and demand points for the price to move through. If, for example, the next resistance area is only 20 cents or pips higher, and you are long, it may not be intelligent to assume prices will move to your price target if it's 80 cents away.
Movements of Price between Supply and Demand
Traders will bid to buy at prior demand and offer to sell at prior supply which can create enough buying or selling pressure to form a reversal at these points. Prices move between areas of supply and demand or create new areas of supply or demand which will affect future price movements. You must assess how potent an area of supply or demand is and update your trend bias as new information enters the marketplace.
When there are price voids that are free of choppiness or congestion to the left on the chart, prices will have better odds of moving freely and more rapidly through that area. When there are multiple areas of congestion to the left on the chart, prices are more likely to struggle and move in a choppier manner.
As prices move sideways, an area of supply or demand is created. A breakout or breakdown from this sideways area has good odds of working out for the trader if the next area of supply or demand is far away in terms of price and there is some kind of tradable price void.
Prices will tend to move in the path of least resistance (a price void). The trader's job is to assess the path that prices will likely move.
A rounding top formation is bearish and more difficult to overcome than a traditional V top where the supply is not as heavy. Many more trades would have taken place in a rounding top which can be seen as a kind of internal struggle between the bulls and the bears. The first pullback after a breakdown from a rounding top will likely result in failed buy patterns as it absorbs the overhead supply. A second buy pattern will have better odds of advancing through the rounding top high since some of the supply was absorbed by the first buy pattern unless there has been a complete breakdown in the market.
It would be wise to anticipate sellers in the area of prior highs and unfilled gaps higher. Anticipate buyers in the areas of prior lows and unfilled gaps lower. The odds of reversals at these points are good especially if you combine the elements of trend analysis with support and resistance.
Moves higher to resistance absorb that supply and make those highs less potent on subsequent tests. Moves lower to support absorbs the demand and makes those lows less potent or significant on future tests.
The wrecking ball concept is a good analogy for supply and demand being absorbed by price tests. The first hit with the wrecking ball may not break down the wall but after a couple of swings the wall crumbles and the wrecking ball moves freely through the wall without effort. Every test of supply or demand weakens it.
Each time a high is challenged by prices the supply that was there is being transferred. Topping tails will absorb overhead supply as aggressive selling took place there signified by the topping tail. Once the high has been overcome it will then become demand on future pullbacks to it. Resistance, once broken higher, becomes support.
If a move occurs leaving no gaps, congestion or choppiness (this is a momentum move) then look further to the left on the chart to find your next area of supply or demand. Unless the stock or market is making all-time highs, there will always be an area of supply to the left on the chart.
At this point, we should have another look at the basic cycle with the 3 trends and add in the supply and demand areas as well as the price void. Keep in mind that the first area of supply is the prior high and the first area of demand is the prior low. However, if the supply or demand is not heavy then prices will be able to move through those areas without difficulty. Figure 5.6 highlights this.
Your job as a trader is to take the middle chunk out of the move, not the entire move from top to bottom. If anyone is telling you that they can pick the exact tops and bottoms in the market they are lying to you and probably have never made a real trade before. Don’t focus on getting every last bit of a price move; there is enough money in the middle chunk of the move to make the kind of money that everyone else dreams of.
Figure 5.6: The Basic Cycle with the 3 trends highlighting supply, demand and price voids. This can be any timeframe from a 1 minute chart all the way to a monthly chart.