Support and resistance

Posted by Scriptaty | 12:42 AM

Support and resistance are concepts that underlie much of the price based analysis used by technically oriented or chart-based traders.

Support is a price level that appears to act as a “floor” preventing prices from dropping below that level. Resistance is the opposite — it’s a price level that seems to act as a “ceiling,” or a barrier to further price gains. Traders often identify such levels visually on price charts, but they also can be defined mathematically. Significant prior highs or lows or the boundaries of well-defined horizontal congestion periods are the most commonly referenced points for support and resistance levels.

Traders generally use support and resistance levels two ways. First, if price is approaching an identifiable support level, traders will sometimes take long positions or cover short trades (assuming no other factors run counter to such actions) in anticipation of a “bounce” off support. The opposite can be true when price is approaching a resistance level — traders can exit long positions or go short in the expectation of a downturn. Second, if instead price “breaks out” above a resistance level, short positions would be covered and new long positions could be opened because this development implies additional upside gains. The opposite would hold true when price breaks below an established support level.

These scenarios are straightforward enough, but the markets don’t make things this simple. Much traditional support and resistance analysis are subjective, making it difficult to test hypotheses on historical data and draw firm conclusions about future performance. However, there are some techniques that can make such concepts more concrete.

Although the terms support and resistance are sometimes used to describe dynamic or diagonal price levels (such as those defined by trendlines and moving averages), we will discuss support and resistance in terms of the kinds of horizontal price levels.

It shows several support and resistance levels in the Euro/Japanese yen rate (EUR/JPY). The March high functioned as resistance; the currency pair rallied twice (in April) near this level before turning back down. In mid-March price bounced off the support level defined by the low made earlier that month. The “breakdown” below that level in April was followed by nearly 300 pips of additional selling over the next several days, and the day before the move, EUR/JPY fell below a shorter-term support level implied by the three-day consolidation in mid-April. The principles of support and resistance are the same on all time frames. It shows a 60-minute chart of EUR/JPY. The minor mid April low from it appears as more of an extended consolidation on this time frame. It is a monthly chart of the U.S. dollar/ Japanese yen (USD/JPY) rate and it is a one-minute chart of the Euro/U.S. dollar (EUR/USD).

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