What is Support and Resistance?
In its most basic form, support is the floor and resistance is the ceiling. In trading, a support level is the level at which the price cannot break. Instead of breaking through this support price, it will tend to bounce off. A resistance level is the same idea, just in the opposite direction as support.
What Determines a Support Level?
A support price level is generally created by a pattern of failure. As trades occur and price moves up and down, there is an invisible line being created as the low that the price cannot break. Normally, a support level is created after three failed attempts of the price to break lower. The price that forms support is a psychological barrier that bears cannot break. Once the level of support is determined, traders will take positions based around that level and be ready to long or short on either side.
When Will Support Be Broken?
After the asset price attempts to break a low and fails three times, the support is said to strengthen. However, looking at it from another angle, the support could also be weakening if the bears are determined to break the support level. If the support level is broken, it will generally become the new ceiling, or resistance.
What Determines a Resistance Level?
A resistance price level is also created by a pattern of failure to the upside. It is a price that the bulls cannot break. Each time the price moves up and fails to break higher, a resistance is formed. This psychological level will also be a basis for traders to create long and short positions directly above and below the resistance level.
When Will Resistance Be Broken?
Resistance strengthens after approximately three failed attempts to break a high. However, if the bulls gain enough momentum, the resistance level would get weaker as they attempt to break higher. If the resistance level is broken, it will generally become the new floor, or support.
What Technicals Show Me Support and Resistance?
The best technical indicators to use for support and resistance are Pivot Point levels and Fibonacci Retracements. Pivot points are easily calculated using open, close, high, and low values for the stock from the previous period.
How to Calculate Pivot Points
Pivot points are relatively simple to calculate and begin with the center pivot or PP.
PP =(High+Low+Close) /3 Resistance 1= (2xPP) –Low Support 1 =(2xPP) – High Resistance 2 = PP + (High –Low) Support 2 = PP – (High-Low) Resistance 3 = High + 2(PP-Low) Support 3 = Low – 2(High – PP)
Each level creates a price range based on the previous day, week, or month; however, if you calculate your own pivot points, you can set the interval to equal whatever you like.
Using Fibonacci Retracements as Support and Resistance
Fibonacci Retracements can easily be used to draw support and resistance levels because they will automatically extend beyond the levels you choose. There is no need to calculate Fibonacci levels; your charting software should do this for you already.
It is important to understand where a support or resistance level may be when using other technical indicators to trade. Your indicators may tell you to go in long but if you are near a resistance level, there will be traders will automatic shorts ready to kill your trade. Pay attention to these levels and you will be a better trader.