Price action trading is a method of analyzing and trading the forex market based on the movements of price, without using any indicators or other tools. It is based on the idea that price reflects all the relevant information and emotions of the market participants, and that by studying the patterns and behaviors of price, traders can gain an edge over the market.
One of the most important concepts in price action trading is support and resistance. Support and resistance are levels or zones where price tends to bounce or break, indicating changes in supply and demand. They act as barriers for price movement, and can help traders identify potential entry and exit points, as well as possible reversals and trend continuations.
In this blog post, we will show you how support and resistance can help you improve your price action trading skills. We will explain how to identify different types of support and resistance levels, how to trade them effectively, and how to use confirmation signals to validate them. By the end of this post, you will have a better understanding of the role of support and resistance in price action trading, and how to use them to manage risk and enhance your performance.
How To Identify Support and Resistance Levels
Support and resistance are levels or zones where price tends to bounce or break, indicating changes in supply and demand. They act as barriers for price movement, and can help traders identify potential entry and exit points, as well as possible reversals and trend continuations.
There are different types of support and resistance levels that can be identified on a chart, depending on their shape, origin, and significance. Here are some of the most common ones:
- Horizontal support and resistance: These are levels where price has previously reversed or consolidated, forming a horizontal barrier for further movement. They are usually drawn by connecting the highs and lows, swing points, or round numbers of price, such as 1.2000, 1.2500, etc. Horizontal support and resistance levels are often the most reliable and widely used by traders, as they tend to hold for a long time and reflect the psychology of the market. For example, in the chart below, we can see how price bounced and broke from the horizontal support and resistance levels marked by the blue lines.
- Diagonal support and resistance: These are trend lines or channels that connect the rising or falling peaks and troughs of price, indicating the direction and strength of the trend. They are usually drawn by using the same logic as horizontal lines, but with a slope. Diagonal support and resistance levels are often used to identify trend continuations and reversals, as well as breakout and pullback opportunities. For example, in the chart below, we can see how price followed the diagonal support and resistance levels marked by the red lines, forming an ascending channel.
- Psychological support and resistance: These are levels that are influenced by human emotions and expectations, such as major Fibonacci ratios, pivot points, and moving averages. They are usually calculated by using mathematical formulas or indicators, and they can act as dynamic support and resistance levels that change over time. Psychological support and resistance levels are often used to identify potential turning points and targets, as well as to measure the volatility and momentum of price. For example, in the chart below, we can see how price reacted to the psychological support and resistance levels marked by the green lines, which are the 50% and 61.8% Fibonacci retracement levels of the previous swing.
These are some of the ways to identify support and resistance levels on a chart, but there are also other methods and techniques that can be used, such as using fractals, Elliott waves, or harmonic patterns. The key is to find the ones that work best for your trading style and strategy, and to use them consistently and objectively.
How To Trade Support and Resistance Levels
Support and resistance are levels or zones where price tends to bounce or break, indicating changes in supply and demand. They act as barriers for price movement, and can help traders identify potential entry and exit points, as well as possible reversals and trend continuations.
However, support and resistance levels are not static or fixed. They can change their role from support to resistance or vice versa, depending on whether price breaks or bounces from them. They can also be strengthened or weakened by the presence of other support and resistance levels, as well as by the confirmation of other signals. Here are some of the ways to trade support and resistance levels effectively:
- Support and resistance reversal: These are situations where a support level becomes a resistance level, or a resistance level becomes a support level, after price breaks through them. This is based on the principle that once a level is broken, it changes its polarity and attracts price from the other side. Support and resistance reversal can offer trading opportunities, as they indicate a change in the market sentiment and direction. For example, in the chart below, we can see how price broke the horizontal resistance level at 1.2000, and then retested it as a support level, before continuing its uptrend.
Support and Resistance Reversal Trading Rules
To trade support and resistance reversal, we can use the following rules:
- Entry: We can enter a long position when price breaks above a resistance level, or a short position when price breaks below a support level. We can also wait for a retest of the broken level, and enter when price bounces from it in the direction of the breakout.
- Stop loss: We can place our stop loss below the broken resistance level (for long positions), or above the broken support level (for short positions), to protect our trade from a false breakout or a reversal.
- Target: We can set our target at the next support or resistance level, or use a risk-reward ratio of at least 1:2, to ensure a positive expectancy.
- Support and resistance confluence: These are areas where multiple support and resistance levels overlap, creating a stronger zone of interest for price action. They can be formed by the combination of horizontal, diagonal, and psychological support and resistance levels, as well as other factors such as previous highs and lows, round numbers, and chart patterns. Support and resistance confluence can offer trading opportunities, as they indicate a high probability of price reaction and a low risk of failure. For example, in the chart below, we can see how price bounced from the support confluence zone formed by the horizontal support level, the 50% Fibonacci retracement level, and the ascending trend line.
Support and Resistance Confluence Trading Rules
To trade support and resistance confluence, we can use the same rules as support and resistance reversal, but with more confidence and caution:
- Entry: We can enter a long position when price bounces from a support confluence zone, or a short position when price bounces from a resistance confluence zone. We can also wait for a confirmation signal, such as a candlestick pattern, to increase the probability of success.
- Stop loss: We can place our stop loss below the support confluence zone (for long positions), or above the resistance confluence zone (for short positions), to protect our trade from a breakout or a continuation.
- Target: We can set our target at the next support or resistance confluence zone, or use a risk-reward ratio of at least 1:3, to ensure a higher reward.
- Support and resistance confirmation: These are signals that validate the strength and validity of a support and resistance level, such as candlestick patterns, volume, and price action patterns. They can help traders confirm the direction and momentum of price, as well as the quality and reliability of the support and resistance level. Support and resistance confirmation can offer trading opportunities, as they indicate a clear and strong price reaction and a high chance of continuation. For example, in the chart below, we can see how price confirmed the resistance level at 1.2500 with a bearish engulfing candlestick pattern, followed by a high volume and a lower high.
Support and Resistance Confirmation Trading Rules
To use support and resistance confirmation, we can use the same rules as support and resistance reversal and confluence, but with more accuracy and precision:
- Entry: We can enter a long position when price confirms a support level with a bullish signal, or a short position when price confirms a resistance level with a bearish signal. We can also use a tighter entry, such as a break of the high or low of the confirmation candle, to reduce the risk and increase the reward.
- Stop loss: We can place our stop loss below the low of the confirmation candle (for long positions), or above the high of the confirmation candle (for short positions), to protect our trade from a reversal or a retracement.
- Target: We can set our target at the next support or resistance level that has not been confirmed, or use a trailing stop loss, to capture the maximum profit.
These are some of the ways to trade support and resistance levels effectively, but there are also other methods and techniques that can be used, such as using multiple time frames, trading ranges, and breakouts. The key is to find the ones that suit your trading style and strategy, and to use them consistently and objectively.
Conclusion
In this blog post, we have learned how support and resistance are key elements of price action trading that can help traders identify trading opportunities, manage risk, and improve their performance. We have explained how to identify different types of support and resistance levels, such as horizontal, diagonal, and psychological, and how to trade them effectively, using concepts such as reversal, confluence, and confirmation. We have also provided some examples of how to apply these concepts on a chart, using entry, stop loss, and target rules.
Support and resistance trading is a simple yet powerful method that can be used by traders of all levels and styles. However, it is not a magic formula that guarantees success. It requires practice, patience, and discipline, as well as a flexible and objective mindset. Here are some tips and recommendations for using support and resistance effectively:
- Do not rely on a single support or resistance level. Use multiple levels and factors to confirm and validate your analysis and decisions.
- Do not draw too many support or resistance lines on your chart. Use only the most significant and relevant ones, and avoid cluttering and confusing your view.
- Do not trade every support or resistance level you see. Wait for the best and most clear setups, and avoid overtrading and risking too much.
- Do not expect support or resistance levels to hold or break every time. Be prepared for false breakouts and bounces, and use stop loss and risk management techniques to protect your capital.
- Do not be afraid to change your bias or opinion when the market conditions change. Support and resistance levels are dynamic and can change their role and significance over time.
We hope you have enjoyed this blog post and learned something new and useful. If you have any feedback, questions, or experiences with support and resistance trading, please feel free to share them in the comments section below. We would love to hear from you and learn from your insights. Thank you for reading and happy trading!
